As of 2011, the United States levies an estate tax of 35 percent on anything over an estate tax exemption of $5 million. There is no tax levied on transfers to surviving spouses, but the tax applies when assets get passed on to children or to any non-spouse individual or entity, with the exception of qualified charities. The law also levies a gift tax, however, that limits your ability to transfer assets tax-free through gifting. Much estate planning takes place in the interrelationship between the estate tax and the gift tax.
As of 2011, you can give up to $13,000 to any individual, without tax consequence. Your spouse can also give up to $13,000 to any individual. One commonly used technique, then, is for each person in a married couple to give the maximum allowance to each member of another married couple. In this way, a set of parents can gift up to $52,000 to a married child's family. However, gift taxes are still subject to a lifetime exemption of $1 million, before the gift tax applies. A generation-skipping transfer tax limits your ability to avoid estate taxes by transferring assets to grandchilden and great-grandchildren.
Benefits of Gifting
In addition to the obvious pleasure in giving money to loved ones while you are still alive to see them enjoy it, gifting can also have longer-term financial benefits. Specifically, anything you gift prior to death does not fall victim to the 35-percent estate tax after you (or if you are married, you and your spouse) pass on.
If you have money in a traditional IRA or 401(k) account you want to give, you must first take a distribution and pay income taxes on that distribution. However, your net tax bill in doing so will, in most cases, be lower than the eventual taxes on the estate, if you have more than $5 million in the taxable estate. This is because only a small minority of taxpayers has a marginal income tax bracket of over 35 percent.
Another estate-reducing strategy is the Roth conversion. By converting IRA assets to Roth IRA assets, you are reducing the amount of your estate that may be subject to the 35-percent tax rate by the amount of taxes you pay to convert. If you have to gift one or the other, you will obtain the most estate tax benefit by gifting a traditional IRA. However, if you are running up against the lifetime exemption limit, you may be able to generate a higher after-tax gift for your family by giving assets from a Roth IRA instead.
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