S.B. from Toms River, N.J., writes:
Q. I'm at the stage of my life where I should reduce the size of my taxable estate. I am thinking of cashing in some mutual funds and giving the proceeds to my six grandchildren (ages 3 to 15). This should reduce my estate, and I can qualify for the gift-tax exclusion. I also want to reduce my assets in case I need to go into a nursing home, but I don't want to lose control of my funds. Does this make sense?
A. Yes, with certain caveats. If you sell your mutual fund shares, you'll generate a current tax liability. Any subsequent earnings on that income will be taxable to the grandchildren at their low rates. But once the grandchild's annual investment income exceeds a specified threshold ($1,600 for 2004), the excess is taxed at the parents' highest marginal tax rate. So you will save income tax overall by transferring proceeds to your grandchildren, but perhaps not quite as much as you envision.
Under current law, you can give each grandchild up to $11,000 a year without paying any gift tax. If you're married, you can double your gifts to $22,000 a year (even if the funds are in your name only).
This allows you to reduce your assets rather quickly. For instance, if your estate is valued at $2 million, you and your spouse can give each of your six grandchildren $22,000 a year for four years in a row. That pushes your estate below the $1.5 million federal estate-tax exemption ($2 million minus $528,000 = $1.472 million). Of course, when you give cash or property to a child, you do lose control over the property. That may be a consideration for you.
Regarding your second question, it's difficult to qualify for Medicaid assistance if you need to go into a nursing home. Under the "look-back" rule, assets transferred out of your estate are usually treated as your assets for a three-year period (five years for transfers to trusts). Also, specific state laws may have an impact in this area.
Key point: Don't do your estate planning in a vacuum. Other issues may affect your gift-giving program. For instance, money given to grandkids may affect their college financial aid eligibility. It's best to hold a frank discussion with your loved ones. Once you determine your objectives, consult with an experienced estate-planning pro.