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Aunty Mae and Inflation: Gifting to Avoid Estate Taxes; Purchasing Power and Inflation

Roger McClure Nov. 29, 2011

Aunty Mae. Aunty Mae consults an estate planner to update her estate plans. She is 80, in good health, a widow, with $2,000,000 in assets, $400,000 of which is her home, which has with no mortgage. She has $80,000 a year of pension income from her deceased husband and social security; most of this income is not indexed for inflation. She spends $60,000 a year, believes that she has all she needs and saves what she does not spend each year. She is thinking of making some gifts to her grandchild. This is December of 2011 and she is a US citizen. She has a ten year life expectancy.

$1,000,000 Exemption. In December of 2011, the estate, gift and generation skipping tax exemptions for Aunty Mae are $5,000,000. However, the current law is that the estate tax exemption will be $1,000,000 starting January 1, 2013 unless Congress and the President are able to agree on a new tax law by then. If she dies after 2012 and there is no change in the law, then Aunty Mae’s estate could pay up to $550,000 in estate taxes plus any additional estate taxes due to the state in which she lives. This assumes that her assets will not increase in value during the next ten years (her life expectancy); but, her assets are likely to substantially increase in value due to her savings rate, the likely appreciation of her assets and the compounding of her rate of savings. Assuming an average increase of seven percent per year (inflation and return on her money combined) in the value of her assets, her $2,000,000 could be worth $4,000,000 in ten years, causing an estate tax of over $2.6 million. If she placed $1,000,000 in trusts for her four grandchildren in 2011 she would pay no taxes on the $1,000,000 transfer. Over the lifetimes of her grandchildren, this money, carefully invested, could provide several millions of dollars for each of the grandchildren’s retirement. This would allow the grandchild to take risks and pursue their dreams, knowing that their retirement was taken care of. Currently, it does not appear that Aunty Mae should need the $1,000,000 for her future needs.

$5,000,000. If the current $5,000,000 exemption is retained, Aunty Mae would probably not have to worry about an estate tax and could make the gifts to her grandchildren as part of her living trust at the time of her death. But, this is a gamble and potential waste of the limited opportunity to make tax free gifts in 2011 and 2012.

Inflation. Aunty Mae remembers paying $0.19 for a loaf of bread that now costs $2. Some commentators are concerned that the federal government’s level of high debt will motivate the federal government to increase inflation so that the federal government will be able to pay down its debt with future cheaper dollars. With all of the financial turmoil in Europe, there are concerns about hyper inflation. Other commentators are concerned about deflation.

Should Aunty Mae Make the Gifts? If there is hyperinflation, Aunty Mae’s $80,000 may only buy her $20,000 of the same goods and services she now receives for $60,000 and she may need all of her $2,000,000 to live on. Given her concern about the present financial turmoil in the world, she decides not to make the gifts to her grandchildren. Her advisors tell her that her financial security has to be the priority and not potential future taxes of $2.6 million and not the hopes and dreams of her grandchildren.

Tough Love. Aunty Mae’s daughter Karen asks Aunty Mae to pay off the $400,000 mortgage on Karen’s house because the lender is foreclosing and the house is now only worth $300,000. Her son Kevin wants to borrow $400,000 for an investment opportunity. Her son Larry needs $2,500 immediately to pay his back rent on the apartment he shares; Larry has spent the last three months at Occupy Wall Street, prefers to stay at home and write poetry and keeps losing his jobs over fights with his employers because they all fail to understand his personal needs. Also, he needs $1000 to replace his stolen laptop. Often Aunty Mae sends $20,000 a year to Larry to keep him afloat.

No Gifts. The advisors of Aunty Mae all advise her against making any gifts to Karen, Kevin or Larry. They adviser her that there is no certainty in this world of financial uncertainty and that she needs to keep her funds for her own future.

Common Dilemma. Aunty Mae is a fictional person and does not refer to any real person, alive or dead. But, her situation illustrates a common dilemma for people trying to plan their futures today, reduce taxes and provide a brighter future for their children and grandchildren.