Giving away assets during your lifetime

July 2009 -- Like many of us, you may want to provide for your family's financial future. At the same time, you may want to decrease the size of your estate to reduce any estate taxes that could be due in the future. In any case, you want to make sure that you are gifting your financial assets in the most tax-efficient manner.

Giving away your financial assets can be more complicated than just writing a check. If you want to engage in lifetime gifting, you should be aware of certain rules. The annual gift tax exclusion amount was $12,000¹ per year per person in 2006. The lifetime federal gift tax exclusion amount is currently $1 million, and it will remain at that level through 2010.

The top federal gift tax rate was incrementally reduced from 46 percent in 2006 to 45 percent in 2007. In 2010, the top gift tax rate will equal the top individual income tax rate (currently 35 percent). Any portion of the gift tax exclusion used will reduce dollar-for-dollar your estate tax exclusion available at death. You should consider some creative lifetime gifts, such as the following.

The grantor retained annuity trust
A GRAT allows you to pass assets you believe will appreciate in value to family members at discounted levels. You contribute assets to a trust and receive a fixed annuity payment stream for a specified period of years. At the end of the trust term, the remaining assets and their appreciation (if any) are distributed to your beneficiaries. Since the value of the gift is reduced by the current value of the annuity payments, you could structure a payment schedule and amount that could result in a minimal gift tax value. However, if you die before the end of the specified term, the trust property would be included in your estate and subject to estate taxes.

Life insurance
You could use life insurance to help replace your estate and gift tax liabilities. Life insurance often provides a substantial benefit for relatively small premium dollars. It may be used by itself to increase the size of your estate, creating an "instant" estate. Or, it may be used for liquidity and paying estate taxes cost-effectively. And, the proceeds of life insurance are typically income-tax-free to the beneficiary. With careful planning, these proceeds may also be received estate-tax-free.

The limited liability company or family limited partnership
An LLC or FLP may help reduce the size of your estate for transfer-tax purposes. The LLC or FLP is made up of managing or voting interests and nonvoting interests, and you could gift the nonvoting interests to your children and grandchildren². Since the nonvoting interests gifted to your children and grandchildren lack voting rights and are not readily marketable, they might be discounted for gift tax valuation purposes³.

The dynasty trust
A dynasty trust could allow you to establish a source of funds for multiple generations. Here's how it generally works. You would fund the trust with an amount up to your and your spouse's lifetime gift tax exclusions. The trust assets, including any growth, will remain free of federal transfer taxes (i.e., estate, gift and generation-skipping transfer taxes) for as long as they remain in the trust. In certain states, such as South Dakota, the trust may theoretically last forever. And the planning could be designed so that any distribution from the dynasty trust would be free of gift and generation-skipping transfer taxes.

Income or principal from the trust may be distributed to your children, grandchildren and great-grandchildren as specified in the trust document. The provisions could tie those distributions to incentives, such as maintaining gainful employment, and permit distributions for funding businesses or purchasing homes for the use of beneficiaries or other activities. There also may be provisions in the trust document to gift a percentage of the assets directly to a charity or family foundation. Assets remaining in the trust are protected from creditors and divorce judgments.

Create your estate plan
Discuss your estate-planning objectives and concerns with your financial consultant and your tax and legal advisers. Together, you can develop an estate plan that addresses your unique financial and family situations so that you can effectively transfer wealth to your beneficiaries.

¹ This amount may be adjusted annually for inflation.

² You should consult with your legal or tax adviser about LLC or FLP planning and the potential tax consequences. The IRS may challenge this planning and take the position that gifted LLX or FLP interests and/or underlying LLC/FLP assets are includable in the donor's estate.

³ You should consult with a qualified appraiser to determine the appropriate amount of the valuation discounts.

Smith Barney is a division and service mark of Citigroup Global Markets Inc. Member SIPC.

Citigroup Inc., its affiliates, and its employees are not in the business of providing tax or legal advice. These materials and any tax-related statements are not intended or written to be used, and cannot be used or relied upon, by any such taxpayer for the purpose of avoiding tax penalties. Tax-related statements, if any, may have been written in connection with the "promotion or marketing" of the transaction(s) or matter(s) addressed by these materials, to the extent allowed by applicable law. Any such taxpayer should seek advice based on the taxpayer's particular circumstances from an independent tax adviser. Patti Lee Heidorn is a financial adviser in West Palm Beach, Fla. She may be reached at Patti.L.Heidorn@SmithBarney.com or 561-820-2388.