Un-Used Annual Gift Tax Exemption
The annual federal gift tax exclusion for 2022 was raised to $16,000 per individual (from $15,000 in 2021). The new cap expands the opportunity to gift cash, securities or other asset annually, up to that threshold to your heirs tax-free and without filing a gift tax return. This can be a valuable estate planning opportunity for many taxpayers. Consider the example of the married couple John and Maria:
John and Maria
John: Age 64, retired business owner
Maria: Age 61 retired volunteer
The case details
John owned a service company and sold it four years ago, amassing net worth at a level significant enough to provide for his and his wife’s income needs for the rest of their lives, with assets left over for the next generation. John and Maria are retired and enjoy an active lifestyle. They have insurance policies through an irrevocable life insurance trust (ILIT), and the premiums are paid from ILIT assets that were gifted to them years ago. This gift used up nearly all of their lifetime estate tax exemption (currently $24.12 million for a married couple). They have two adult children and their primary goal is to pass as much wealth to them as possible with the greatest tax efficiency.
John and Maria do not currently engage in annual gifting to their kids. For 2022, they have the opportunity to gift up to $16,000 per spouse, per child, per year without having to file a gift tax return or potentially pay gift tax, on $64,000. Although they can gift the $64,000 to their kids directly, they decide instead to gift it to their ILIT, which will own a newly purchased life insurance policy with the children as the sole beneficiaries.
The survivorship life insurance policy with a $64,000 annual premium will provide a tax-free death benefit* of $4,385,000.
Why the solution fits the situation
- John and Maria are conservative investors and invest the majority of their assets in moderate risk portfolios and fixed income. The internal rate of return (IRR) on the life insurance is 3.32% at life expectancy. Because their tax rate is 40%, the taxable equivalent of the IRR is 5.53% (IRR of 3.32% / Tax Rate factor 0.60%).
- This life insurance product is guaranteed* to age 120, which makes the IRR guaranteed and highly attractive for their risk tolerance and expectations.
- The clients have a taxable estate that exceeds the estate tax exclusion, meaning every dollar above the exclusion will be taxed at 40%. Using dollars inside the taxable estate to pay insurance premiums reduces the taxable estate by the premium amount of $64,000 annually. This means every dollar in the trust today will be worth only 60 cents at death after a 40% federal estate tax is imposed.
- The beneficiaries of the ILIT can get access to the cash value of the life insurance policy in the form of withdrawals and loans should they need capital.
- The clients were able to accomplish their main goal of passing value to the next generation in a tax-efficient way.
- The clients secured a tax-free, guaranteed death benefit of $4,385,000*.
- The guaranteed death benefit* taxable equivalent IRR of 5.53% is greater than the yield on the fixed income portfolio, which makes it an attractive return for their long-term planning.
- The clients were able to reduce their taxable estate by $64,000 annually, essentially saving 40% of every dollar that would otherwise go to federal estate taxes.
- They were able to place the assets in a trust that gives the beneficiaries access to cash values.
*Marcum Insurance Services, LLC is an affiliated insurance agency of Marcum Wealth, LLC. Marcum Wealth, LLC may recommend the services of certain affiliated and related entities, including Marcum, LLP and Marcum Insurance Services, LLC, which presents a conflict of interest in that the recommendation could be made on the basis of fees to be collected by such affiliated or related entity.
*Securities offered through Valmark Securities, Inc. Member FINRA, SIPC. Advisory Services Offered through Marcum Wealth, a SEC registered Investment Advisor. Marcum Wealth and Marcum Insurance Services are separate from Valmark Securities, Inc.
*The information presented here is for educational purpose only and is not intended to provide specific advice or recommendations for any individual nor does it take into account the particular investment objectives, financial situation or needs of individual investors. Actual results may vary. All examples are hypothetical in nature and are for illustrative purposes only.
* Past performance may not be indicative of future results. Different types of investments involve varying degrees of risk. Therefore, it should not be assumed that future performance of any specific investment or investment strategy or any non-investment related services, will be profitable, equal any historical performance level(s), be suitable for your portfolio or individual situation, or prove successful.
*Marcum is neither a law firm, nor a certified public accounting firm, and no portion of its services should be construed as legal or accounting advice. Moreover, you should not assume that any discussion or information contained in this document serves as the receipt of, or as a substitute for, personalized investment advice from Marcum.
*The guarantees offered by insurance policies are limited to the claims paying ability of the issuing insurance company.