Deciding When to Transfer Wealth: Factors to Consider

Should you transfer wealth during your lifetime or transfer it to heirs after your death? Answering this question can be complicated because many factors are involved.

For example, you might want to take advantage of the inflation-adjusted $12.06-million gift and estate tax exemption now, since the exemption amount is scheduled to be cut approximately in half after 2025 (unless Congress acts). On the other hand, transferring assets to loved ones now could burden them with higher taxes.

Now or Later?

The primary advantage of making lifetime gifts is that by removing assets from your estate, you shield future appreciation from estate taxes. But there's a tradeoff: Your beneficiaries receive a "carryover" tax basis — they assume your basis in the asset. If a gifted asset has a low basis relative to its fair market value (FMV), then a sale will trigger capital gains taxes on the difference.

An asset transferred at death, however, receives a "stepped-up basis" equal to its date-of-death FMV. That means recipients can sell it shortly after receiving it with little or no capital gains tax liability. So, the question becomes, which strategy has the lower tax cost: transferring an asset by gift now or by bequest later? The answer depends on many factors. They include the asset's basis-to-FMV ratio, the likelihood that its value will continue appreciating, your current or potential future exposure to gift and estate taxes, and your recipient's time horizon. This is how long you expect the recipient to hold the asset after receiving it.

Testing the Options

In the following fictional examples, let's assume that you and your heirs are subject to tax on capital gains at a rate of 23.8% (the top capital gains rate of 20% plus the 3.8% rate on net investment income) and that the gift and estate tax rate is 40% of amounts in excess of the applicable exemption.

1. You have $8 million in publicly traded securities with a $3-million basis and $2 million in other assets. You haven't used any of your exemption amount. If you give the securities to your daughter, who sells them immediately, she'll owe $1.19 million in capital gains taxes (23.8% × [$8 million - $3 million]). Suppose, instead, that you hold the securities for life, that the inflation-adjusted exemption in the year you die is $12 million, and that the securities' value has grown to $13 million. If your daughter inherits the securities, she'll receive a stepped-up basis of $13 million and can sell them tax-free shortly after your death. Your estate will be subject to estate taxes of $400,000 (40% × [$13 million - $12 million exemption]). In this scenario, holding the securities is the better strategy for the family from a tax perspective.
2. Using the same facts as the first example, let's say your daughter plans to hold the securities for life rather than sell them. In this scenario, gifting the securities now is the better strategy because, by holding them, your daughter avoids capital gains taxes. Also, there's no estate tax because all future appreciation is removed from your estate.
3. To add a twist to the same scenario, let's suppose that when you die the exemption has dropped to $6 million. That makes your estate subject to estate taxes of $2.8 million (40% × [$13 million - $6 million exemption]). In this example, gifting the securities now results in a substantially lower tax bill, even if your daughter sells them immediately.

Wealth-Transfer Realities Demand Expert Guidance

Obviously, the previous three examples are simplified to illustrate the decision-making process and don't include all the real-life details you'll likely encounter when making a wealth-transfer plan. The recipient's financial condition, state income and estate taxes, and possible changes in tax rates could all affect your decision.

In fact, the complexity of transferring wealth now or later practically demands expert advice. We can walk you through the decision and help you determine what makes the best sense given your unique situation.