With the November election fast approaching, the conversation around preserving the current $13.61 million federal estate and gift tax exemptions has intensified.
Many advisors are urging clients to "use it or lose it." But for high-net-worth individuals, are large lifetime gifts truly as advantageous as they seem at first glance? Is there a more effective alternative that could yield better results for the client and their family?
Preserving the Exemptions The current large federal estate and gift tax exemptions are set to sunset in 2026. At that point, the exemptions could be reduced by 50% or more—from $14 million to under $7 million for individuals, and from $28 million to less than $14 million for married couples. With the federal estate tax rate sitting at 40%, the potential estate tax impact for a married couple could exceed $5.6 million.
Given these numbers, it might seem like a no-brainer for high-net-worth individuals to gift as much as possible under the current exemption before the sunset. Estate planning attorneys have developed tools like Spousal Limited Access Trusts (SLATs), which allow couples to transfer substantial assets while retaining indirect access to them during their lifetimes. However, this decision is not as straightforward as it appears, and there is at least one alternative that should be considered first.
One key issue is that gifts of around $6 million or less per person have no grandfathering effect under the tax code. Clients must gift more than this threshold to capture the benefit of the current $13.61 million exemption. This means transferring a significant portion of their assets, which can be a daunting step for many individuals, especially married couples looking to double that amount.
Furthermore, while SLATs and similar strategies are designed to provide lifetime access to transferred assets, it is uncertain whether these plans will withstand IRS scrutiny. Even if such a plan is upheld during the couple’s joint lifetimes, upon the death of the first spouse, the surviving spouse may only have access to half of the trust's assets—or none at all, depending on how the trust was structured.
The Limited After-Tax Benefits of Large Gifts Another factor to consider is that the after-tax advantages of large lifetime gifts may be more limited than initially thought. For instance, suppose a client makes a $10 million gift of securities in 2024, and the federal estate and gift tax exemption drops to $6.5 million in 2026. In this case, the client would have grandfathered $3.5 million of the larger exemption, saving $1.4 million in estate taxes. However, if the securities have a tax basis of $4 million, and the donee's combined capital gains tax rate is 23%, the built-in capital gains tax would also be $1.4 million—essentially wiping out the estate tax savings.
This example highlights a critical point: large gifts of appreciated securities or business interests often carry significant built-in capital gains taxes, which would be avoided if the assets were retained until death. If the exemption sunset never occurs, or if the tax laws are later changed to restore the higher exemptions, the client could find that their gift actually disadvantaged their family in the short term.
Portability and Lifetime Gifting Clients with a significant "portability election" amount from a predeceased spouse face additional complications. The portability election essentially allows a surviving spouse to utilize their deceased spouse’s unused estate tax exemption. However, lifetime gifts by the surviving spouse use up the portability amount before touching their own exemption. As a result, there is no immediate tax savings after the transfer of the portability amount, and the surviving spouse could also face a significant capital gains tax hit due to the carryover basis of the gifted assets.
Future Appreciation and the 17% Advantage If the goal of large lifetime gifts is to remove future appreciation from the estate, the calculation becomes more nuanced. At a 23% capital gains tax rate, the net tax advantage of making a lifetime gift should be about 17% (40% estate tax rate minus 23% capital gains tax) of the future appreciation. For example, if $10 million in assets were gifted and those assets doubled in value every decade, growing to $80 million after 30 years, the net tax savings to the client’s family could be approximately $11.9 million. However, this scenario assumes significant appreciation and no changes in the tax laws, which introduces uncertainty.
The Life Insurance Alternative Is there a more secure alternative that offers similar or better financial benefits without requiring the client to relinquish control of their assets? Consider the use of life insurance.
Take the example of a married couple with a 62-year-old husband and a 61-year-old wife, both in preferred health. Instead of gifting $10 million in securities, the couple could retain full control of those assets and use a portion of the ordinary income generated—roughly $148,700 per year based on their ages and health—to pay the premium on a $12 million second-to-die life insurance policy. The policy would be held in an irrevocable life insurance trust (ILIT), and the annual premium would be covered by the couple’s $18,000 per Crummey power donee annual gift tax exclusions.
Because the life insurance proceeds are both income-tax-free and estate-tax-free, this strategy allows the couple to preserve control over their $10 million in assets while achieving a comparable result in terms of wealth transfer. If they pay the $148,700 premium for 30 years, the total cost would be $4.46 million. If the $148,700 annual premium were instead invested at 7% annual growth, it would grow to $14 million, but after 40% estate taxes, the net amount would only be $8.4 million—70% of the $12 million income- and estate-tax-free life insurance payout.
Alternatively, if the couple invested the $148,700 annually in an irrevocable trust outside of their estate, the net amount after 23% capital gains tax on all growth would be about $11.8 million—roughly equivalent to the $12 million life insurance payout.
Conclusion: Consider All Options While the facts will vary in each client’s case, this analysis shows that grandfathering the current federal estate and gift tax exemption may not always be necessary or financially beneficial. Before clients lock in large gifts, with the associated loss of control and potential exposure to higher future capital gains taxes, they should consider life insurance as a compelling alternative. It offers comparable financial benefits while allowing clients to retain full control of their assets, ensuring greater flexibility and long-term planning advantages.
