By Peter Mastrantuono
A strategy for transferring assets to adult children needs to balance many considerations, including the tax implications of each available option, the future financial needs of the parents, and the financial personality and capabilities of the adult child.
Three Approaches to Transferring Assets
Transfers During Lifetime: Each parent can give up to $15,000 each year to each child without incurring any gift taxes.
Gifts above that amount may escape taxation by using the lifetime gift and estate tax exemption, which is presently $11.58 million for each parent, or $23.16 million for married couples. Using this exemption during a person’s lifetime will reduce the amount of the estate tax exclusion at time of the donor’s death.
The two primary advantages to giving away assets during a person’s lifetime are that the child(ren) get use of the assets immediately and the future appreciation of those assets is removed from the donor’s estate, potentially lowering future estate taxes.
There are, however, two key disadvantages to this strategy. One is that the cost basis of the property gifted during the donor’s lifetime is transferred to the recipient of that gift, forfeiting the step-up in cost basis that occurs at death.
For instance, if a parent gives a child a parcel of land or shares in a company with a current market value of $100,000 that has a cost basis of $10,000, the child, if he or she subsequently sells it, will pay capital gains taxes on the sale amount over $10,000. If the child receives this inheritance upon a parent’s death, the cost basis is raised to the current market value at the time of the parent’s death, potentially reducing substantially the capital gains tax owed on a subsequent sale.
The second potential disadvantage is that the parents lose access to the gifted assets, which means that in the event of adverse developments, they will not have those funds to meet their financial obligations.
Transfers by Revocable Trust: Parents can decide to place their assets into a revocable living trust, which allows them full control and access to those assets, but which at the time of death transfers immediately to the named beneficiaries of that trust, avoiding the delays associated with probate court.
There are certain assets that cannot be placed in a living trust (e.g., IRA, 401(k), Health Savings Account) and other assets (e.g., cars, life insurance) that may involve complications tied to individual state law considerations.
Transfers by Irrevocable Trust: Placing assets in an irrevocable trust is typically done to minimize estate taxation or protect assets from creditors, but they may be useful in situations where children are minors, financially irresponsible or have special needs.
With an irrevocable trust, the trustee (a trusted individual or corporate fiduciary) is responsible for investing the assets prudently and making distributions to beneficiaries in accordance with the terms of the trust, e.g., “begin distributions at age 35” or “use funds only to pay for education and medical expenses.”
Devising an intelligent strategy for transferring assets should be done with the guidance of an estate planning lawyer and in concert with a financial advisor who is familiar with your financial circumstances and goals.
Peter Mastrantuono is a contributing writer to MyPerfectFinancialAdvisor, the premier matchmaker between investors and advisors. Peter worked for over 30 years in the wealth management industry, focusing on retirement planning, investing, asset allocation and financial planning.
