tax planning

The Best Gifting Strategy of Our Era

With taxes likely to rise in the coming decades, the normal methods of providing a financial legacy for our family could be heavily taxed. But, by cleverly using life insurance policies, there are a few ways to safely provide for our children without incurring estate taxes.

My son is 22 years old. He is a sweet guy, but not yet experienced with money.  As parents, we all want what is best for our kids.  We also want to ensure that they will be financially safe once we leave this world.  I believe we are all wired to provide a legacy plan for our spouse, children and favorite charitable causes.

This often creates a paradox in our legacy plan.  Our basic desire to leave resources to the next generation could also be the greatest obstacle to their development in life.  Put in another way, you can love your 15-year old son, and giving is a good thing, but I am sure nobody reading this article believes giving $200,000 to a 15-year-old boy would ever be a good thing!

Wouldn’t we all love a way to leave a legacy to our kids that provided them cash flow in retirement?  Given current low interest rates, we would love to add growth and security to this investment plan.  Income and estate tax rates are likely to rise in the future due to the recent and ongoing increases in our national debt.  What if we could create an income strategy that was estate tax free, no matter what the future tax laws might be? 

Sounds like a utopia, but it is not.  We can currently achieve these objectives given a combination of factors. 

Being Tactful with Taxes

Before we get into the opportunity, we need to face some facts.  After the big spend of World War I, top marginal income tax rates went from 7% to over 70%.  After World War II, they rose above 90% and stayed there for roughly 20 years; estate tax rates were almost as high.  And now in 2020, we are borrowing yet again at extremely high levels.  The highest marginal income and estate tax rates are highly likely to rise for the next generation — perhaps double, perhaps even worse. 

If you believe tax rates will rise for our kids and grandkids, wouldn’t it make sense to anticipate that today, and take advantage of the opportunities we have now?

There are very few ways to receive income that is free from tax.  Most people know life insurance proceeds are free from income tax, but nobody wants to die to achieve that objective!  But what if we could have a life insurance policy with equity built up, then borrow against our own future death proceeds while we are living?  Life insurance proceeds are income tax free, but so are loans from a life insurance plan.  Yes, I just said your heirs can borrow against their future death proceeds income tax free, then someday when they pass, the life insurance proceeds pay back the loan and interest income tax free, with the remaining life insurance proceeds going to their own heirs.

Legacy Gifting for the 21st Century

There can be challenges gifting money to children and grandchildren.  However, if you gift the premiums to a life insurance policy, you can accomplish this through a trust.  It is called an Irrevocable Life Insurance Trust (ILIT).  The advantage of this is that you can control the ultimate distributions now, and your gifts — along with their growth — are no longer part of your estate, thereby avoiding any future estate tax.

Back to my son.  I have been very blessed in my career and understand how hard it is for young people today.  This is especially true where I live in the Pacific Northwest, where $500,000 cannot get you a three-bedroom house in most towns.  I will likely help him with a down payment someday. 

 That is my “now-money” plan. Here is my “long-term” gifting plan, the subject of my article:  A fixed-indexed universal life (FIUL) policy is the mechanism to achieve my legacy goal. I believe I will have a taxable estate when I pass.  Rather than volunteer much — or most — of the value of my estate to taxes, I would like my son, when he enters his 60s to receive a significant monthly cash flow, permanently tax-free.

I hope he is happy and financially successful during his life.  But what if he is not?  I know today, when I implement this strategy, long after I have passed, my son could potentially receive decades of cash flow, no matter the state of Social Security.  He will also have a monthly, income tax-free reminder of how much I cared for, and loved him. 

As a side note, if you have a net worth above $5 million, there are even more advanced opportunities beyond the scope of this article.  There are many nuances to implementing this strategy, but I hope this piqued your interest to find out more about what I believe is the best gifting strategy of our era.

Madrona Financial Services' registration with the SEC does not imply a certain level of skill or training. Advisory services are only provided after receipt of disclosure documents and execution of an advisory agreement. The information, suggestions and recommendations included in this material are for informational purposes only and do not constitute financial, legal or accounting advice. Hypothetical returns shown illustrate mathematical principles only and are not intended to predict or project the return of any actual investment.
Insurance products are offered through Madrona Insurance Services, LLC, a licensed insurance agency and affiliate of Madrona Financial Services. Some products discussed in this article are only available to accredited investors and are offered solely through the issuer's offering documents. The issuer determines whether to accept any individual’s subscription documents. DST investments are only available to accredited investors and are offered solely through the issuer's offering documents. The DST sponsor determines whether to accept any individual’s subscription documents.

About the Author

Brian Evans, CPA, PFS

Owner, Madrona Financial Services

Brian Evans is the owner of Madrona Financial Services, Madrona Funds, LLC, and Bauer Evans CPAs and serves as the firms' chief investment officer, lead planner and senior portfolio manager. He was honored to ring the bell on the NYSE. Evans also hosts a weekly radio show on KTTH 770 AM, KRKO 1380 AM and KVI 570 AM, is a nationally published author and has been a regular guest on New Day Northwest, CNBC and Fox television.

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