Latest / The Financial Freedom Podcast with Fexingo: Quitting Your Job, Living Off Investments, Independence / The Invisible Gift Tax That Drains Early Retirees
Transcript
- Lucas: So, Luna, a listener named Jen wrote in — she's about three years into early retirement, living off her portfolio, and she wants to help her son with a down payment on a house. She's thinking of gifting him $30,000. Luna: That's generous. And also — if she's not careful — a potential IRS headache. Lucas: Exactly. The gift tax is one of those things that a lot of early retirees don't think about, because they assume it only applies to the ultra-wealthy. But the rules kick in at levels that are actually pretty accessible. And if you don't file correctly, the IRS can come back years later and say that gift ate into your lifetime exemption without you realising it. Luna: And that matters a lot if you're doing estate planning later. I think a lot of listeners might not even know there's an annual exclusion. Lucas: Right. For 2026, the annual gift tax exclusion is $18,000 per person per recipient. So Jen could give her son $18,000, and her spouse — if she has one — could give another $18,000, and that's $36,000 totally tax-free, no filing required. Luna: But she wants to give $30,000, and if she's single, that's $12,000 over the limit. Lucas: Exactly. Now, that doesn't mean she owes tax right away. It means she has to file Form 709 with the IRS, and that $12,000 gets subtracted from her lifetime estate and gift tax exemption, which for 2026 is $13.99 million per person. So unless she expects to die with more than that, she likely won't owe any tax. But she does have to file the form. Luna: And that's the trap — people skip the filing because they assume no tax is due. Then years later, if she's done this multiple times, the IRS could argue she's used up more of her exemption than she reported. Lucas: Right. And here's the thing — if this conversation has been useful to you, we'd love for you to support the show. If today was worth a coffee to you, you can find us at buy me a coffee dot com slash fexingo. No pressure, but listener support is what keeps this ad-free and focused on what actually matters for your financial independence. Luna: Yeah, we really appreciate it. It's a small way to help us keep going. Lucas: So back to Jen. She has options. One is to simply split the gift across two years — give $15,000 this year and $15,000 next year. Then each gift is under the $18,000 exclusion and no filing needed. Luna: But if her son needs the money now, that doesn't work. Lucas: True. Another option: she can directly pay the tuition or medical expenses for her son. Those payments are unlimited and not subject to gift tax, as long as they're paid directly to the institution. So if she wants to help with his kids' college tuition, that's a workaround. Luna: That's a big one. A lot of grandparents don't realise that paying tuition directly doesn't count as a gift. Lucas: For the down payment specifically, though, she's probably stuck with the gift. But she can also consider gifting appreciated stock instead of cash. If she has a low-cost-basis stock in her taxable account, she can gift that to her son. He then sells it and pays capital gains at his own rate, which might be lower than hers. Luna: But the gift is still valued at the fair market value when she transfers it, so it still counts against the exclusion. Lucas: Yes, but it's more tax-efficient overall because the unrealised gains leave her portfolio without her ever paying tax on them. And her son gets a step-up in basis? Actually no — for gifts, the recipient's basis is the same as the giver's. So the son inherits the original cost basis. That's different from inheritance, where you get a step-up. Luna: Right. So if she's planning to leave a legacy, it might be better to hold onto the low-basis stock and let her heirs get the step-up at death. But if she wants to help now, gifting the stock can still be smart. Lucas: Another strategy is a grantor retained annuity trust, or GRAT. That's more advanced, but it allows her to transfer appreciation on assets to her son without using up much of her gift exemption. She puts assets into a trust, pays herself an annuity for a set number of years, and anything left over goes to her son gift-tax-free. Luna: That works well in a low-interest-rate environment, but with rates where they are now in mid-2026, it might not be as attractive. Lucas: Yeah, the IRS uses a Section 7520 rate to calculate the annuity, and when that rate is higher, the trust has to pay out more to avoid eating into the exemption. So the window for GRATs is narrower right now. Luna: Let's also talk about the state level. Some states have their own gift tax or a lower estate tax exemption. For example, if Jen lives in Connecticut or Washington, state rules could apply. Lucas: Good point. Most states don't have a gift tax, but a handful do, and they often have much lower exemptions. So someone with $5 million could be above the state threshold even if they're well below the federal one. Luna: And then there's the issue of retirement accounts. If Jen's wealth is mostly in her IRA or 401, gifting from those accounts is treated differently. She'd have to withdraw the money first, pay income tax on it, and then gift the after-tax amount. Lucas: That's a huge inefficiency. So ideally, you want to gift from taxable accounts, not retirement accounts. And if you have to go into a retirement account, consider doing a Roth conversion first so you pay the tax at a known rate. Luna: One more thing — the $18,000 exclusion is per recipient per year. So Jen could give $18,000 to her son, $18,000 to his spouse, and $18,000 to each grandchild, all without filing. That's a lot of money moving tax-free. Lucas: Right, and that's the best strategy for most early retirees: spread gifts across multiple recipients and across years. Filing Form 709 isn't that hard — it's just a few extra pages with your tax return — but if you can avoid it entirely by staying under the per-person limit, that's simpler. Luna: And if you do need to file, keep a record. The IRS can audit years later and you'll want to show you properly reported the gift. Lucas: So the takeaway for Jen — and anyone in early retirement — is that helping family is great, but know the rules. The annual exclusion, direct payments for tuition or medical, splitting gifts with a spouse, and thinking about the type of asset you're gifting can all make a big difference. And if you're ever unsure, a few hundred dollars for a CPA is money well spent. Luna: Yeah, because a mistake here can cost you thousands in missed exemption later. And no one wants to discover that ten years down the road. Lucas: Exactly. Alright, that's it for this episode. Thanks for listening, and we'll talk to you next time.