“The love you express to your children is infinitely more valuable than any possession you could give them. You can educate them in prestigious schools, dress them in the finest clothes, guide them with the wisest rules, and boldly confront their worst fears. But, if they do not rest in your unconditional love, you are neglecting a much more vital need for their true success in life.” – The Love Dare for Parents
Those words of wisdom ring very true. If there is unconditional love within the walls of a household, then being a good financial steward will be more often than not a byproduct. Knowing that is first and foremost with respect to guiding your children or grandchildren, you may, in addition, want to bless them with monetary gifts. Here are five sound ways to do so:
1) Annual exclusion gift – In 2015, $14,000 can be gifted to any individual without any reporting or paperwork to the IRS. A husband and wife can combine their gifts (known as “splitting” gifts, for some reason) to give $28,000 to one child/grandchild each year while still falling under this annual exemption. Splitting gifts do require the filing of Form 709. Amounts over the $14,000 require a gift tax return to be filed and will reduce the amount you can leave tax free at death (currently $5,340,000), unless those gifts are to pay for college tuition or medical bills directly in which case there is no limit.
2) Start a Roth IRA – As long as the recipient has earned income, 100% of that amount can be contributed to a Roth IRA in their name up to $5,500 in 2015. If they earned $500 mowing lawns, you could either outright gift them $500 or create an incentive where you will match dollar for dollar what they contribute, up to the lesser of their earned income level or the $5,500 amount. Monies in a Roth IRA grow tax-free and the power of compound growth over 40+ years will set them up for success!
3) Contribute to a 529 plan in their name – These monies also grow tax-free in the same fashion as a Roth IRA and as long as the money is taken out for qualified educational expenses there is no tax paid upon withdrawal either. Most 529 plans offer a state tax deduction to the contributor (Nebraska’s maxes out at $10,000 for 2015). So it can be a double winner as well!
4) Gift appreciated assets to a Uniform Gift to Minors Account (UGMA) – This is a great way to gift to anyone in a lower tax bracket. For children, as long as you keep the “kiddie tax” rules in mind you will be reducing the amount of actual tax paid when the appreciated security is sold. Keep in mind that UGMA account beneficiaries become sole owners of the monies at age of majority (18 or 19 in most states).
5) Start an irrevocable trust for your child or children – This strategy will involve legal paperwork and likely an attorney to help you draft the parameters of the trust. For good reason though, as you would be able to control the distribution schedule of the monies contributed and the trust would be treated as a separate taxable entity. Unlike a UGMA account, the dollars remain controlled by the trust and are directed by the trust agreement. For example, if you have two or three children, each could be named as a beneficiary of the trust. You can either state that at certain ages (30, 40, 50 or whatever you choose) a portion of the trust is to be distributed. Or you could make it at the discretion of the trustee and could distribute funds at certain milestone events (wedding, first house, first child, etc.). Irrevocable trusts are taxed at their own tax rate.
So there’s five ways to stretch your gifting dollars by avoiding the payment of unnecessary taxes. By reducing your tax bite, you’ll have more money to gift to children or charities or to spend enjoying life. One or all of those should appeal to you. As always, please consult P&A, your accountant or attorney before embarking on one of these strategies to make sure they make sense given your unique financial situation.