Lifetime Versus Testamentary Gifts

We are in the midst of a traditional season of gifting and though it looks different, as do many things in 2020, we are still able to enjoy some of our favorite traditions and perhaps create a few new ones this year, as well. Often overlooked in our gift giving are the benefits and drawbacks associated with significant gifts to our beneficiaries during our lifetime as opposed to waiting until we pass away. The former are commonly referred to as lifetime gifts and the latter are known as testamentary gifts.

Often, there is an appropriate place for both lifetime and testamentary gifts in our planning process once we understand how each align with our goals. If you stop reading right here, the best advice to take away from this article is to bring your professional advisors into the conversation, including your Greenleaf Trust Client Centric Team, your estate planning attorney, and your CPA. There is no one-size-fits-all strategy for gifting and, while we will review some common considerations below, your personal team of advisors are well positioned to provide advice that will help you make the best decision for your situation.

As we consider when to make gifts to our future heirs there are both tax and non-tax consequences to weigh. Gifts to heirs during your lifetime afford you the opportunity to see your loved ones benefit from the gift and often to enjoy the gift during a period in their lives when it can be more impactful. This also provides a window into how well prepared your heirs are to receive a potential inheritance when you pass away (did they even say thank you?).

Some heirs may surprise you, for better or worse! Seeing how heirs respond to gifts while you are living provides you valuable time to craft your estate plan in a fashion you believe will be most likely to benefit those you care about after you are gone, providing you with greater peace of mind.

With proper planning, lifetime gifts also provide an opportunity to remove assets from your estate which are expected to achieve above average appreciation. This can help to reduce the ultimate size of your estate and potentially reduce taxes owed at your death. Additionally, careful selection of assets can allow you to shift assets with greater annual tax liability from yourself to heirs who may be in a lower tax bracket.

From a tax perspective, annual gifts to individuals during your lifetime that are $15,000 or less are within the annual exclusion amount permitted under current law, meaning that those gifts do not count toward a donor’s lifetime exclusion limit before gift or estate tax is due. Do keep in mind that for these gifts to fall under the annual exclusion rules the recipient needs to have a “present interest” in the gift. Therefore, with a few exceptions, these gifts are generally given outright to the recipient with no strings attached.

Gifts in excess of $15,000, adjusted annually for inflation, do require a gift tax form to be filed with the IRS and may result in a gift tax due if the donor has exceeded their lifetime exclusion amount. The lifetime exclusion amount ($11,580,000 in 2020) is the amount a person is able to pass to heirs during their lifetime or at death before gift or estate tax will be owed.

A notable exception for gifts in excess of $15,000 applies when the gift is for tuition or medical payments. These gifts can be for any amount so long as the payment is made directly to the school or medical provider and education payments are limited to tuition only.

Additionally, if you are making gifts directly to an individual’s 529 account, you are permitted to “front-end load” up to five years of annual exclusion gifts in a single year. This exception results in the ability to contribute $75,000 to a 529 account in one year. Though you would not be able to make annual exclusion gifts to that person for the next four years, you will have sped up the investment in their education, allowing additional time for the contribution to be invested.

From a tax perspective, lifetime gifts and testamentary gifts have some competing advantages and disadvantages. When a person’s estate exceeds the lifetime exclusion amount there can still be a tax benefit to making gifts during one’s lifetime. This is the case because the calculation for gift tax due is less punitive than the calculation for estate tax due. Gift tax is calculated on a tax exclusive basis while estate tax is tax inclusive. Essentially, with estate tax you are not able to exclude from the calculation the amount that will be used to pay the tax (you are being taxed on the tax). With gift tax, on the other hand, you are not taxed on the amount being used to pay the tax.

The tax exclusive nature of the gift tax is a benefit for those who will owe estate tax, but assets that are instead transferred after a person’s death enjoy what is known as a step-up in basis. This step-up in basis often results in tax savings upon the sale of an asset by the heir because they do not inherit the donor’s original tax basis. Instead the heir’s tax basis is equal to the asset’s value on the donor’s date of death. As a result, highly appreciated assets are often best kept within a person’s estate and assets with less appreciation are typically a better fit for lifetime gifts.

It is important to note the obvious: lifetime gifts are permanent! You should not complete gifts during your lifetime if there is a reasonable possibility that those funds will be needed for your own living expenses or for estate liquidity at your passing. It is important to stress the need to carefully consider the long-term consequences of lifetime gifts on your own ability to meet your needs and goals.

With this article we have just scratched the surface of the benefits and drawbacks associated with gifting to heirs during your lifetime or at your passing. I encourage you to reach out to your Client Centric Team and seek their expertise as you consider what is best for you and your loved ones.

Enjoy this season of giving and stay safe!