Estate Planning: Gifting versus Bequething

Gifting versus bequeathing calculators

If you anticipate having a sizable estate remaining at your death, after you have fulfilled all your own medical and other needs and responsibilities while living, then you may, under a number of circumstances, consider giving away your assets to loved ones and charities while you are alive rather than passing them on at death. On the other hand if you think you may out-live your assets you probably shouldn’t be gifting. There is a lot of longevity in my family as well as my wife’s family and I am not yet confident I will not out-live my assets. Hence, all I have gifted so far are for my children’s educational 529’s and some crummy T-shirts to my wife and daughter with the art work at the bottom of this page. If however, you anticipate living frugally off your pensions and the interest on your asset base, you can continue reading and try my calculator.

The calculators were inspired by a reading by Stephen Horan which was part of the CFA institute level III program. Horan has provided expressions for the relative value of gifting versus bequeathing using rules regarding estate planning and gifting in the global context. A calculator for those expressions are in the second tab of our excel web application. Our calculator for the US specializes these general rules to estate planning regulations in the United States and is in the first tab of the excel web application. Horan’s generally applicable expressions, the citation for that reference and the expressions in the US context are provided in this hyperlinked document. I have provided in my US calculators, as a default, three scenarios involving moderate, high and very high anticipated assets at bequest.

Inputs to the US Gifting Calculator

Inputs to the US calculator include estate related inputs, inputs for non-charity recipients such as family and friends and inputs for charitable recipients.

Estate related inputs include the anticipated estate size at bequest in the absence of gifting. The next item refers to whether you contribute as an individual or with your spouse or partner. The gift amount. The individual annual gifting limit with current or possible future taxation – in 2016 you can gift up to $14,000 per donor per recipient. (Note that this rule can be very beneficial to high net worth individuals with a large number of beneficiaries as the limit applies to each beneficiary) Your eventual estate tax limit comes down by amounts in excess of this amount. Individuals with eventual estates in excess of the estate tax limit will have future tax liability at bequest in the event of gifts exceeding $14,000 per recipient. The individual estate tax exemption limit in 2016 amounted to $5,450,000. This limit increases yearly. Estimate the limit at the time of your bequest. The estate tax rate rate in 2016 for estates exceeding exemption limits amounts to 40%. The next input is the pre-tax return on investments for the donor. The effective tax rate on investment returns by the estate would depend on the mix of cash, short term and long term investments held by the estate. Enter the expected time until the donor’s death depending on the donor’s age and anticipated survival. For details on the donor’s gross adjusted income and the tax rate on ordinary income see my calculator at this page.

Non-charity recipient related inputs include the pre-tax return of the gift recipient and the effective tax rate on investment returns for the recipient. An advantage for gifting arises when these inputs are more favorable for the recipient than for the estate.

Charity recipient inputs include the pre-tax return and the effective tax rate. Typically the effective tax rate is 0% as charities are typically not taxed. However, the IRS notes that certain investments by charities are taxable. There are limits on the percent of the gross adjusted income of the donor which is deductible. This is typically 50% but depending on the nature of the charity it may be lower at 30% (see details in the attached document).

Three US gifting versus bequeathing scenarios

We will look at key inputs and calculated quantities for three scenarios. In the first scenario there is a moderate estimated pre-tax bequest of $1 million for a single contributor. Since it is a single contributor, the gifting limit is the same as the individual gifting limit of $14,000 and the estate tax exemption limit is the same as the individual estate tax exemption limit of $5.45 million. This individual’s gift of $14,000 is equal to the gifting limit and there are no tax consequences to the donor on gifting. Further since the tax exemption limit is much higher than the bequest the estate will not be taxed on the donor’s death. In such a context, as there is no taxation at either gifting or bequeathing, there would be no net gain on gifting compared to the bequest if the recipient and the donor had the same rate of investment returns and the same effective tax rates. However, gifting tends to help in such cases as this equality on return and taxation may not hold as a recipient is typically younger and has less income that the donor and may have more favorable returns and lower effective tax rates. For the first scenario we considered a return rates of 4% and 6% for the donor and recipient respectively and effective tax rates of 15% and 10%. From the bottom of the second box in the calculator we see that the after tax value of gifting is, to the recipient, 1.333 fold higher than receiving it as a bequest. From the bottom of the third box in the calculator we see that charitable gifting the value of gifting to the charity is 2.016 fold higher than the incremental value of the estate should the gift be withheld. The relative value of gifting is higher since charities typically have zero taxation on investment returns and the donor has tax savings on donating to a charity.

In the second scenario there is a high estimated pre-tax bequest of $7.5 million for a couple. Since it is a couple, the gifting limit is twice  the individual gifting limit at $28,000 and the estate tax exemption limit is twice the individual estate tax exemption limit at $10.9 million. This couple’s gift of $100,000 is above the gifting limit and there could be future tax consequences due to the lowering of the estate tax exemption limit by $100,000 – 28,000 = $72,000. However since the tax exemption limit, despite a decrease, is much higher than the bequest, the estate will not be taxed on the donor’s death. As in scenario 1, there will be no taxation at either gifting or bequest. Thus for the same return rates and effective tax rates for donor and recipient, gifting is 1.333 fold better, as in scenario 1. The relative value of charitable gifting is higher, at 2.166 fold, than in scenario 1 as this couple has a higher tax rate on ordinary income compared to the individual in scenario 1 and has higher tax savings on making a charitable contribution.

In the third scenario there is a very high estimated pre-tax bequest of $17 million for couple. Since it is a couple, the gifting limit is twice  the individual gifting limit at $28,000 and the estate tax exemption limit is twice the individual estate tax exemption limit at $10.9 million. This couple’s gift of $500,000 is above the gifting limit and there could be future tax consequences due to the lowering of the estate tax exemption limit by $500,000 – 28,000 = $472,000. In this case since the bequest is higher than the tax exemption limit (and more so after applying the decrease to the tax exemption limit) the estate will be taxed at bequest. In this manner, this context differs from scenarios 1 and 2. Gifting is 1.608 fold better than bequeathing and charitable gifting has a 2.98 factor relative value.

Gifting versus bequeathing in the global context

The second tab of the calculator provides the relative after tax value of making a gift when living compared to passing wealth on death in a more global context. For non-charitable gifting, these calculations are provided in the context of gifting which is tax free to the recipient and the donor, a gift which leads to a tax on the recipient and a gift which leads to taxes on the donor. It is assumed that the gifting is being considered by donors who anticipated estate at death exceeds a limit above which estate taxes are applied or that the donor lives in a country where estate taxes apply for estates of any size.

Inputs, additional to those described for the US calculator, are the tax rates on gifts for the donor and the recipient. The relative after tax of making a gift is given by the ratio of the future value of one currency unit to the recipient to the future value to the estate if this one currency unit had been retained by the estate. For the scenario presented the relative value of gifting was 2.222, 1.777, 1.955 and 2.699 in the tax free, recipient taxable, donor taxable and charitable contexts respectively.

Edit the blue cells in the spreadsheet and enter your data and the calculations in the bottom boxes of the spreadsheet will refresh. If you appreciate our efforts and would like to make a voluntary contribution of any amount to help us maintain and improve this site please do so at this link. 

As noted earlier gifting may not be recommended if you think you will outlive your assets. There is a lot of longevity in my family as well as my wife’s family and I am not yet confident I will not out-live my assets. Hence, all I have gifted so far are for my children’s educational 529’s and some crummy T-shirts to my wife and daughter with the art work below. Wish you all a lot of net worth so you can treat your cutie pie’s a lot better!

Cutie Pie