Inheritance vs. Gift: Which is Better for Your Beneficiaries?
Updated: Apr 13
Are you planning on leaving behind money for family members after your death? You may have a lot of questions when it comes to choosing to leave an inheritance or gifting them money while you are still living. Either option may have a different tax implication. You do need to be aware of any tax consequences before making a final choice in the matter. It’s essential to have the correct information so you can compare gifts versus an inheritance for your beneficiaries.
What’s the difference between a gift and an inheritance?
Transferring your wealth to the next generation is a great way to preserve your legacy. It also helps your loved ones have a stable financial foundation for their future. You have numerous options for passing on your wealth, including giving some of your assets away during your lifetime. You may choose to leave your heirs and inheritance when you die. What’s the difference between a gift and an inheritance? The primary difference between a gift and an inheritance is the time each occurs. A gift is an asset passed on during a person's lifetime, whereas an inheritance is passed on after the person’s death.
Is an Inheritance a Gift or Income?
A gift and an inheritance can have different tax implications. When money is gifted to a beneficiary while a person is still alive, taxes are not imposed unless it surpasses $17,000. Gifts $17,000 and less fall under a gift tax exemption. Any amount over $17,000 requires the recipient to file a gift tax return. For example, if a person is gifted $25,000, then the $17,000 falls under the annual exclusion, but the remaining $8,000 will be taxed. Keep in mind that the annual exclusion is applied to an individual. For those who would like to give amounts that surpass the annual exclusion, they can give it to multiple people or organizations. For example, a couple can give an individual double the annual amount before a gift tax return would need to be filed. Technically, each spouse can gift up to the amount of the annual exclusion.
Each state has its own laws regarding estate taxes and laws when it comes to an inheritance. A few states impose an inheritance tax, which is based on the amount of assets being transferred to the beneficiary. The tax rates on inheritances can vary based on the relationship to the giver. An inheritance is not considered income, however, if the beneficiary earns income from the inheritance, it can increase the tax liability. For example, if an individual inherited stocks, the dividends earned from those stocks would be taxable income.
Which is Better for your beneficiaries: Inheritance or Gift
If you plan on leaving money to family members, which is better, leaving it as a gift while you are still living, or giving it as an inheritance once you pass? Each option presents a different tax situation. Both scenarios have pros and cons worth considering.
Even though you are not obligated to leave your children an inheritance, it can be beneficial for your family. If you do not designate how your money or assets are to be distributed upon your death, there are laws to provide guidance. Most parents leave money to their children. Some people leave an inheritance to close friends or a charity they feel strongly about. There are pros and cons to leaving an inheritance.
The main reason most people leave an inheritance is to provide financial benefits to their family members. When you plan to leave an inheritance, you can help your loved ones avoid probate court. When someone inherits cash, property, or investments, they are not considered income for tax purposes. However, income gained from interest will be reported as income.
There are also some cons and challenges that can arise when leaving an inheritance. There may be other claimants who felt like they deserved part of the inheritance that can lead to extensive legal battles. If you fail to plan properly, a big chunk of your money and assets can be eaten up in taxes. Having a financial planner help you plan for your inheritance can help prevent common mistakes. They can make sure the legal details are covered so that your estate plan works as you desire.
There are often both financial and personal benefits to giving assets or money to your loved ones while you are still alive. There may be some potential tax benefits and the satisfaction of knowing you are helping your kids and grandkids. Gifting money to your loved ones during your lifetime can allow you the use of the annual exemption from taxes. The IRS allows an individual to make contributions to educational or medical expenses tax free. Gifting early can help reduce inheritance taxes as well as help your loved ones skip probate court.
There are also some cons that go along with early giving. If you give away assets or money, you take a risk of running yourself short on finances later in life. Even if you give the money to close family members, you are not likely to get help when you need it later. Distributing your money early can cause some of your family members to feel left out or shortchanged. It also eliminates a windfall for heirs later on. Family members who do not exhibit wise spending habits may squander the money and miss the full benefit.
Which is best for you? Should you choose to give to your loved ones early or plan to leave them an inheritance when you die? There are pros and cons to each decision and your choice may be influenced by numerous factors, including the amount of money you are sharing, how taxes may be levied, and how your beneficiaries plan on using it. Our firm specializes in helping people make hard choices and makes sure all the financial bases are covered so that monies are distributed as desired. Contact us today for a complimentary assessment.
The opinions expressed herein are those of Andrew Cremé and not necessarily those of Raymond James. Opinions are as of this date and are subject to change without notice. The information has been obtained from sources considered to be reliable, but we do not guarantee that the foregoing material is accurate or complete. Any information is not a complete summary or statement of all available data necessary for making an investment decision and does not constitute a recommendation. Prior to making an investment decision, please consult with your financial advisor about your individual situation. Examples are hypothetical and meant for illustrative purposes only. Please note, changes in tax laws may occur at any time and could have a substantial impact upon each person's situation. While we are familiar with the tax provisions of the issues presented herein, as Financial Advisors of RJFS, we do not provide advice on tax or legal matters. You should discuss tax or legal matters with the appropriate professional.