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Lifetime Gifting Strategy Part I: The Math of Lifetime Giving

People make gifts for two primary reasons. One is “head” based; the gift lowers the giver’s tax burden. The second is “heart” based; the gift makes a positive and desired impact on people the giver cares about. The first part of this post will focus on head; next month’s will focus on heart.

Tax Consequences of Giving

Under our tax system, anyone can give an unlimited amount of property to a spouse without taxes. But gifts to other family or friends is subject to the transfer tax system. The “transfer tax system” is comprised of two interdependent taxes: gift taxes for gratuitous lifetime transfers and estate taxes for transfers at death. Under the wording of the Internal Revenue Code, all gifts or bequests are subject to taxation, that tax imposed on the person transferring the property. However, the Code does provide a couple of key exceptions to taxation, those exceptions create “tools” that can be used to impact loved ones without taxation.

The first tool is the annual exclusion. In 2025, any person can give $19,000 worth of property to any other person without the imposition of gift tax. That amount not only annually resets (an additional annual exclusion gift can be made tax free in 2026 and every year after during the life of the donor), but the amount is also indexed for inflation. Also, while gifts generally require the donor to file a Federal Gift Tax return on IRS form 709, annual exclusion gifts do not have any filing requirements. So many people, wanting to avoid both gift tax and burdensome filing requirements, limit their gifts to $19,000 per recipient.

In fact, there is a fair amount of “unfounded wisdom” that making gifts in excess of the $19,000 per year are subject to a 40% gift tax. That is not the case. Once a gift to an individual exceeds the annual exclusion amount, any excess is offset by the second giving tool provided by the Code. That tool is what is known, colloquially, as the Lifetime Exemption. In 2025, that Lifetime Exemption amount is $13.99 million. In other words, based on current law, once the donor exceeds the annual exclusion, he or she can make around $14 million in lifetime cumulative gifts. Such amount, while indexed for inflation, does not “reset” like the annual exclusion. Any unused Lifetime Exemption can be used to offset any estate tax due at the person’s death (the estate tax is equal to (1) the value of the property owned or “controlled” by the decedent at death multiplied by (2) a 40% estate tax rate). Finally, the use of the Lifetime Exemption needs to be coupled by the filing of a gift tax return.

The Math of Lifetime Giving

As mentioned above, one of the main reasons people make gifts is to reduce that person’s transfer tax. And that reduction in what is paid in tax increases the future impact of the transferred wealth.

There are a couple of reasons why gifts, rather than bequests, lower the donor’s transfer tax burden. First, the annual exclusion applies only to gifts, not to bequests. In 2025, a $19,000 gift is gift-tax free. A $19,000 bequest is not estate-tax free. Second, it is important to remember how the gift and estate taxes are calculated: They are taxes imposed on the transferor based on the value of the property at the time of the transfer. Assume that a person is considering property that will be invested for growth, rather than spent:

  • If that property appreciates at 7%, within ten years, the value of the property will double.
  • In 20 years, the property will quadruple. 
  • In 30 years, the property will grow in value by a multiple of eight.
  • Now consider that if the investor is 50 years old, his or her life expectancy is about 30 years. So, if the investor continues to own the property, never spends the principal or the growth, and dies owning it, the estate tax burden is eight times greater than if he or she had given the property away in year one!

When does the math matter?

Going back to the tools, the math of gifting only matters when a person incurs more tax by not making gifts than by making them. How is that determined? This is the process:

  • The advisor prepares a financial plan based on several critical assumptions: life expectancy, income, spending, saving, investing, growth, inflation.
  • That plan informs the advisor and client whether there will be an estate tax based on those assumptions.
  • If there will be an estate tax, the plan is rebuilt to assume that certain property is given away.
  • The plan then ensures:
    • The client’s spending needs can be met by retained property
    • The overall transfer tax burden is reduced by making the gift
    • The overall value of assets going to the children is increased

Once that analysis is performed and the mathematical power of giving is proven, we know that-mathematically- a gift should be made. But there are still several client concerns that need to be addressed in making the gifts:

  • What are the client’s values concerning how the transferred money is used?
  • Does the client want to ensure that the assets can only be used in furtherance of those values? If so, can that be ensured over transferred property?
  • What is the advisor’s and client’s confidence that desired spending can be met by retained assets?
  • Which assets should be given away?
  • Is the recipient ready to manage the transferred wealth?

Those concerns will be addressed in the second part of this post next month.

As seen in Advisorpedia.com