If you’re fortunate to have enough wealth to transfer to your family members upon your death, you might want to start thinking about ways to distribute it now, to reduce the size of your estate and potential estate taxes. The IRS allows you to make gifts up to a certain limit each year without being taxed at the federal level. Additionally, there are several exceptions to this rule—notably, paying for someone else’s educational or medical expenses—that enable you to make sizable gifts that may be exempt from federal taxation.
The following options may help you transfer wealth and care for your loved ones without incurring an unwanted tax bill.
Annual Exclusion Gifts
Although lifetime gifts and transfers are taxed according to a unified transfer tax schedule, each year, the first $15,000 (2019 limit) you gift to each person is excluded from the total amount of taxable gifts you make in the same calendar year. If you’re married, you and your spouse may gift twice this amount through gift-splitting (which requires the filing of a federal gift tax return) without generating a taxable transfer of assets.
Annual exclusion gifts do not have to be gifted outright to the beneficiary. Certain vehicles for gifting allow you to retain varying levels of control over the gifted assets.
- The Uniform Transfers to Minors Act (UTMA). An UTMA is a simple and inexpensive way to make a gift to a minor. When you make a gift to an UTMA account, the money or assets are transferred to a custodian for the benefit of the minor. These assets can then be used to make payments directly to the minor or for the minor’s benefit. However, once the minor reaches the age of majority the custodianship of the account terminates, and all proceeds are distributed to the minor, who gains control of the assets.
- IRC Section 2503(c) Trusts. In this type of trust, the money or assets you gift are transferred to a professional manager, who serves as a trustee for the minor’s benefit and makes discretionary distributions. Like an UTMA, any undistributed assets are passed to the minor when they turn 21.
- Funded Crummey Trusts. A Crummey Trust is a longer-term option for a present interest gift. When a gift is made to the trust, the beneficiary is given a specified period to withdraw those assets. If the beneficiary fails to do so, the power lapses and the assets will remain in trust. One of the benefits of this vehicle is that the grantor can determine how long the assets remain in trust—there is no age limit at which the beneficiary must gain control of the assets.
Another option for transferring funds is to simply make a loan to your child. While lending money to family members requires some of the same formalities as a traditional bank loan, the interest rate you charge can be much more favorable. A minimum interest rate must be charged based on the applicable federal rate , which is set each month by the Treasury. It should be noted that any interest charged is considered taxable income. However, you ultimately have the option of forgiving the loan, at which point the remaining balance generally would be considered a gift to the borrower.
Education Expenses and Education Plan Funding
The IRS allows you to pay for anyone’s educational expenses without incurring federal taxes, so long as you pay the educational institution directly. Education payments can be made for any level of education, and you have the option of paying annually or prepaying for multiple years. A potential downside to prepaying, however, is that you may forfeit those payments if the student doesn’t attend the same institution or complete his or her education.
You also have the option of contributing to a Section 529 Education Savings Plan (529 Plan). A 529 Plan is a vehicle for holding gifts, including annual exclusion gifts, which are exempt from federal taxes if those gifts are made for college, vocational, or other accredited schooling and related expenses.
- The law currently allows lump-sum deposits into 529 Plans of up to $75,000 per person or $150,000 per married couple, so long as an election is made on your gift tax return to spread the lump-sum deposit across five years.
- If you die before the end of the five-year period, the portion of your gift reflecting the number of outstanding years will be included in your estate.
Medical and Dental Expenses
Like educational expenses, you can pay for anyone’s medical expenses without incurring federal taxes if you pay the provider of the service directly. Medical and dental expenses may include a wide range of treatments related to the diagnosis, cure, mitigation, treatment, or prevention of disease—and only if it is not covered by insurance.
If you’re considering any of these options, be sure to consult with your tax accountant or wealth advisor to determine whether your plan is within the IRS guidelines for tax exemption. Gifting assets or paying for a loved one’s educational or medical expenses can be a fulfilling and advantageous way to transfer your wealth during your lifetime.