Inheritance: Later vs. Giving Now?

Most of us don’t want to just enjoy our retirement and have enough money for old age, but to leave something behind as well. But what's the best way to do that? Should you leave an inheritance, or give your money away while you're still around?

Let’s take a look at the tax implications of both scenarios.

A recent MarketWatch article, titled “Why it’s better to give than to bequeath,”reminds us that with both gifts and inheritances, it’s the person giving the money who pays the tax. So, for example, if you give a gift or an inheritance to your children, they don’t pay taxes—it will be your estate that has the tax liability and must pay. However, there are huge tax differences between gifts and inheritances. The gift tax is exclusive: it’s on top of the gift.

Estate taxes don’t come into play for individuals with estates less than $5.43 million (or a married couple with an estate smaller than $10.86 million). There is an exemption from tax liability for most of us, as it’s really just 1 percent of the population that needs to be concerned. But even though this isn’t going to apply to you now, you should know the difference between gifting and leaving an inheritance. The article tells us that it wasn’t long ago that the tax-free amount was merely a fraction of what it is now. There is no guarantee that the United States won’t someday revert to that early framework, especially with our country’s deficits and the need for tax revenue.

For example, if the person leaving the inheritance or making the gift has $1 million over the tax-free amount, if you were in the 40 percent tax bracket and gave a million dollars to an heir—you’d also have to cut a check to the IRS for 40 percent, or $400,000. So that’s a total of $1.4 million: a million to your donee and $400,000 to the IRS.

The article explains that the inheritance tax is inclusive. If you began with that same $1.4 million, but left it as an inheritance rather than a gift, 40 percent of it would go to estate taxes. The IRS would see a tidy sum of $560,000, and your heirs would get the remaining $840,000.

See the difference?

In both scenarios, you started with $1.4 million dollars, but in the first situation, your donee ended up with a million, and in the other, the person who inherited ended up with just $840,000.

So, when it comes to taxes, it is better to gift while you're alive than to leave an inheritance after you pass away. Even though this discussion is pretty much irrelevant for all but a very wealthy few, remember that gifting is still more efficient than leaving an inheritance. The other benefit of gifting is that you get to enjoy the experience of giving with your friends and loved ones.

For more detailed information and how this could apply to your specific situation, get in touch with a qualified estate planning attorney.

For additional information about estate planning and estate tax consequences in Houston, please visit my website.

Reference: MarketWatch (May 4, 2015)“Why it’s better to give than to bequeath”