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Five Easy Generational Wealth Transfer Tips

Mar 7, 2022 | Insights

Have you ever thought about how you can transfer wealth immediately, without facing any tax consequences? Perhaps the best-known way of transferring wealth tax-free is by giving money or assets to a qualified charitable organization. There’s no limit to the amount that can be given to a qualified charity. Cash contributions are deductible from adjusted gross income, while non-cash asset contributions are subject to certain deduction limits.

Another way of transferring wealth tax-free is through the use of the unlimited marital deduction. Many people don’t realize that unlimited gifts to spouses weren’t codified into law until 1982. An individual can transfer an unlimited amount of assets to their spouse at any time, free from tax. One caveat to that—if the spouse is a non-U.S. citizen, that tax-free amount is limited to $164,000 in 2022.

So, what do you do if you want to transfer assets to someone other than your spouse or a charity? The gift tax rate ranges from 18% to 40%, so how can you avoid it? Luckily, there are several ways to accomplish that. Let’s look at some of the ways to immediately transfer wealth while avoiding the gift tax.

1. Annual Gift Tax Exclusion

In 2022, the annual gift tax exclusion allows you to give $16,000 per recipient tax-free (this is up from $15,000 in 2021). There’s no paperwork you need to fill out, and no limit to the number of recipients that you can give it to. If there are 10 people you want to give the maximum amount to, that’s $160,000 you can give away without facing any tax consequences.

If you’re married, you can effectively double the amount you can transfer to someone, although it does involve some paperwork. If your spouse agrees to make a split gift, you can give $32,000 to each recipient without triggering a gift tax. In order to do this, your spouse must agree to split the gift with you, and you have to file Form 709 with the IRS.

How can you get the most “bang for your buck” if you’re going to give someone a gift? While giving cash is always an option (and often the easiest one), gifting an appreciating asset is often recommended. That allows the recipient to benefit from the appreciating value while you gift it at its non-appreciated price.

2. Lifetime Estate and Gift Tax Exemption

What if you want to give more than $16,000 (or $32,000 if splitting the gift with a spouse) to someone? Is it possible to give more than that without paying a gift tax? Yes, although once again, it does require filing a form with the IRS.

In 2022, the estate tax exemption is $12.06 million for an individual ($24.12 million for a couple’s combined estate tax exemption). You can use all or part of that estate tax exemption to exempt gifts from tax, although it reduces the amount you can leave tax-free at death. So, if you’re an individual who wants to transfer $100,000 this year to someone tax-free, the first $16,000 can be done with no paperwork, and the remaining $84,000 can come from your lifetime estate tax exemption (reducing your future estate tax exemption by $84,000). While you must file a gift tax return by April 15 of the following year, no tax is assessed on the gift.

There are reasons to start using your lifetime estate tax exemption now rather than waiting. If you use the entire $12.06 million now, and it goes up by $300,000 in 2023, that’s another $300,000 you can use then. But if it goes down in the future (and under current law, the exemption is scheduled to be cut in half in 2026), you’re taking advantage of the higher exemption amount now to transfer more of your wealth tax-free. Even if the amount goes down in the future, there’s no “clawback” to make you pay gift tax on what you’ve already transferred.

3. Tuition

In addition to utilizing the annual gift tax exclusion and the lifetime estate and gift tax exemption, there’s another way to make a significant tax-free wealth transfer, and that’s by paying someone else’s tuition. Under current rules in the Internal Revenue Code, you can pay unlimited amounts for someone’s tuition at a qualified educational institution without being taxed on the tuition payment.

There are a couple caveats to keep in mind. First, the tuition payment should be made directly to the school, not the student. Second, it can only be for tuition, and can’t include things like room and board, books, supplies, etc. And third, to be a qualifying school, it must maintain a regular faculty and curriculum and have a regular body of students attending the place where educational activities are conducted (in other words, what is traditionally thought of as a school).

By following all those rules, you can transfer a significant amount of money tax-free. The tuition payments don’t just have to be for college, either. If the person attends a private grade school or high school, you can pay tuition to those institutions as well.

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4. Medical Expenses

Another way to help someone without incurring the gift tax is to pay their medical expenses. Similar to tuition payments, medical expense payments must be made directly to the health care provider or the company that provides medical insurance. You can pay for the diagnosis, cure, mitigation, treatment, or prevention of disease, if you pay the hospital, physician, or medical provider directly.

While the Internal Revenue Code’s definition of medical care (and hence medical expenses) is extremely broad, there is a notable area that it does not cover. Cosmetic surgery, unless it is to correct a birth defect or disfigurement from injury or disease, is not covered under the medical expenses that can be paid without being considered a gift.

5. 529 Plans

A 529 plan is a tax-advantaged savings plan originally designed to encourage saving for future college costs. We say “originally” because families can now use 529 plans to pay for up to $10,000 in tuition expenses at elementary or secondary public, private, or parochial school. Earnings in a 529 plan grow tax-free, and withdrawals are tax-free as well when the funds are used to pay for qualified expenses.

The Internal Revenue Code allows you to contribute five times the annual exclusion amount to a 529 plan per beneficiary in a single year and avoid the gift tax. That means that in 2022, you could contribute $80,000 to a 529 plan for someone without triggering a tax (that gift would preclude you from making any gifts to them over the following four years). While simply a way to accelerate using the annual gift tax exclusion, when combined with the ability to pay tuition directly to a qualified institution, it can be a powerful way to pay for the education costs of a friend or family member.

How to Get Started

If you’re looking to transfer wealth with little or no tax consequences, there are options out there. Contact your trusted financial advisor, and they should be able to give you advice and guide you through the process.