Safe Ways to Give Wealth

Gift giving is the surest way to reduce estate taxes, help loved ones of all ages, and establish a legacy. Yet, many people are hesitant to make significant gifts to loved ones, because of some potential pitfalls. Those pitfalls, however, can be avoided with some shrewd and creative giving strategies.

Potential givers see several risks in making substantial gifts. The wealth could be wasted or spent unwisely by the recipients. Simple mismanagement by an unsophisticated heir might cause the money to disappear in scams or unwise investments. The wealth also could be dissipated though gambling, substance abuse, or bankruptcy. A common concern is that part of the wealth eventually could leave the family in a divorce.

While these risks are real, there are ways to give that reduce or eliminate the risks without the expense and inconvenience of trusts. As I have stated in past posts, this is a good time to make estate planning gifts, because asset values are down. Estate and gift taxes are based on the value of property. The lower the value of property is when it leaves your hands, the lower the transfer taxes. The benefits of making gifts today can be reaped while protecting wealth from these and other perils. Consider these strategies for structuring gifts.

529 plans. College savings plans authorized under section 529 of the tax code have become one of the best estate planning vehicles in recent years, while tax law changes have diminished the value of other vehicles. Most states now offer multiple 529 plan options, and any person can set up an account for the benefit of someone else and contribute to it. Contributions qualify for the annual gift tax exclusion, currently up to $13,000 per year. In addition, up to five years' worth of exclusions can be used in one year for a tax free lump sum contribution of up to $65,000. The money given to the account is out of the donor’s estate. Under many state plans the owner has some choices over how the account is invested. The IRS generally restricts investment changes to one per year, though the limit is suspended for 2009.

Income and gains in the account compound tax free. Withdrawals are tax free if they are used for qualified education expenses of the beneficiary.

A distinctive advantage of the 529 plan is the owner can retrieve assets from the account for any reason. There is no tax penalty if the owner asks for the return of the assets, though the plan sponsor can impose a penalty of up to 10%. The owner also can change the plan beneficiary at any time. The return of income and gains earned by the account is taxable if they are not used for qualified education expenses.

Some states limit the duration of an account to a number of years or to the 25th or 30th birthday of the initial beneficiary. Others have no time limit.

A 529 college savings plan provides a tax-free way to remove assets from an estate, place them in a tax-free savings vehicle, and benefit an heir. But the beneficiary has no current control of the assets and can be denied future access if the situation changes. The donor can retrieve the assets if his or her needs change.

Bill paying assistance. Many people hesitate to make gifts because they are concerned the gifts will be wasted. They would like to help loved ones but do not want their gifts funding frivolous expenditures or being lost in unwise investments.

One way to prevent that outcome is to make direct payments on behalf of the beneficiary. The beneficiary never touches the money, and the gifts pay for what the donor intended. For example, checks for education or medical expenses can be written and sent directly to the provider. Some people pay directly for vacations, summer camps, furniture, clothing, cars, and whatever other expenses they want to help with.

Direct payment of gifts qualifies for the annual gift tax exclusion. In addition, qualified education and medical expense payments made directly to the provider qualify for unlimited gift tax exclusions.

Purchasing services is safer than paying for assets. Assets can be divided in a divorce or sold or pawned to fund other spending. Another possible disadvantage is that paying for items might put loved ones in the habit of asking for assistance whenever they want something. A better approach is to have a plan in which gifts for the year are discussed and set or even multi-year plans are developed.

Home equity match. Suppose loved ones need an expensive item, but the parents are not able or willing to part with a large lump sum or want to stay within the annual gift tax exclusion limit. A strategy, if the children have adequate home equity and credit, is for the children to make the purchase with a home equity loan. The parents then can agree to make all or part of the loan payments either directly or by sending money to the children. This allows the parents to help the children, stay within the gift tax exemption amount, and spread the payments over time in manageable amounts. The children deduct the interest.

Expense matching. Some donors to charities make challenge matches. They offer to match, up to a maximum amount, whatever amount the charity raises from other donors for a specific purpose. Parents can do the same with children. If the children need or want a car, for example, the parents can offer to match whatever amount the children spend. The match does not have to be dollar for dollar. The parents can offer to pay fifty cents for every dollar the children pay, for example.

Some parents believe it is important the children have some of their own assets in a major expenditure. The cost sharing makes it more likely that the children will choose wisely and take care of the asset. It also makes the children less dependent on the parents.

Marital agreements. When gifts are not made because the parents do not want to risk that they will be divided in a divorce, parents should discuss this with the children. The problem could be remedied with a premarital or postmarital agreement stating any lifetime gifts or estate bequests received by one spouse will not be considered part of the marital estate to be divided in a divorce. Many parents and grandparents will not make estate planning gifts unless there is such a marital agreement.

Maintaining separate accounts. In many states assets owned before a marriage plus gifts and inheritances are not included in the marital estate if they are not commingled with other assets. Parents should check the state's treatment of the gifts, and then can require that their gifts be kept in separate financial accounts

Trusts. Of course, the classic way to protect assets is by placing them in trusts. In this post we have offered a number of ways to protect assets without the expense and restrictions of a trust. When the strategies discussed here do not meet the donor’s goals, trusts can be fashioned to accept tax-free gifts, take property out of an estate, protect assets, and provide incentives for the beneficiaries.

Estate owners have legitimate concerns about what might become of their estate planning gifts. These concerns can be resolved with some creative gift giving, enhancing the lives of loved ones while protecting hard-earned wealth.


Bob Carlson is editor of the monthly newsletter Retirement Watch and the web site He also is author of numerous books and reports, including The New Rules of Retirement and Invest Like a Fox…Not Like a Hedgehog.

Posted 04-24-2009 8:49 AM by Bob Carlson