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4 Next Generation Gifts for Many Happy Returns

January 2, 2019
Judith Ward, CFP®, Senior Financial Planner
There are multiple strategies and accounts that can be used for gifting money to children.

Key Points

  • Education costs can be paid for by funding 529 accounts or by paying the institution directly for tuition expenses.
  • Setting up a Roth IRA or custodial IRA can help a child learn about long-term investing, particularly if you choose to match contributions.
  • UGMA and UTMA accounts allow you to gift and transfer any amount of money, securities, and even property to a minor.

When it comes to shopping for children in your life, it may be hard to find the perfect gift. But some of the best gifts for kids are not wrapped in shiny paper and bows.

Helping your younger loved ones financially is one gift that will always fit. Here are four ways you can make a difference for a grandchild, niece, nephew, or any other child in your life.

1. Contribute to a 529 college savings plan.

Money in a 529 college savings plan grows tax-deferred, and distributions are tax-free when used for qualified educational expenses. The money can be used at nearly any college across the country.

  • Individuals can contribute up to $15,000 in 2018 and 2019 per beneficiary ($30,000 for married couples “splitting” the gift per person) to qualify for the annual federal gift tax exclusion.
  • What’s unique about a 529 plan is that individuals can “front load” contributions. This means you can contribute up to five times the annual federal gift tax exclusion amount in the first year but account for it over five years. For example, if you contribute $75,000 in the first year, you can receive the gift tax exclusion each of the next five years for $15,000 per year. However, you cannot make any additional gifts to the same beneficiary during that time. If you are splitting the gifting with your spouse, you can contribute up to $150,000 in one year.
  • If you make a gift to an account that’s already established in the parent’s name with the child as a beneficiary, this arrangement has the least impact on future federal financial aid. Many 529 plan providers make it easy for family and friends to “gift” to an existing account.
  • If an account doesn’t already exist, you can certainly open one for the benefit of the child. Any future distributions from the account, however, may have a slightly larger impact on federal financial aid eligibility.  

2. Or pay their college tuition directly to the institution.

Yup, it’s just that simple. The benefit of paying the school directly is that the amount doesn’t count toward the annual gift tax exclusion limit, and there is no restriction on how much you can pay. Keep in mind that payments can only be made for tuition and the amount of the payment may impact the student’s financial aid eligibility in future years.

3. Put money toward a Roth IRA.

If the child has any earned income from a summer, part- or full-time job, he or she can open a Roth IRA, or you may be able to fund a custodial (minor) Roth IRA. A Roth IRA provides future growth opportunity and flexibility. While there is no tax break upfront, a Roth IRA provides tax-free income in retirement. Contributions can be taken out at any time tax-free. And withdrawal of earnings can be made penalty-free in some circumstances prior to age 59½.*

Want to go the extra mile? Offer to match each dollar that the child contributes to a Roth IRA. Or you can simply fund the account in total up to the allowable amount. That way, the child can experience the value of saving for a financial goal, without contributing a sizable portion of what was earned. It’s a terrific opportunity to teach important lessons with money and the value of saving toward a goal.

Here are a few additional things to keep in mind with Roth IRAs:

  • For 2018, contribution amounts are the lesser of his or her earned income up to $5,500. The contribution limit increases to $6,000 in 2019.
  • Depending on the financial institution, there may be an age requirement and account minimum to open a Roth IRA.
  • Finally, Roth IRA assets do not factor into the federal financial aid formula. If money is withdrawn from the account to pay for college expenses, the income will be considered in the eligibility process in future years.

4. Give financial assets through a United Gifts to Minors Act (UGMA) or United Transfers to Minors Act (UTMA) custodial account.

These accounts allow you to gift and transfer any amount of money, securities, and even property to a minor. While the funds in UGMAs and UTMAs can be used for any purpose later in the child’s life, it’s important to note:

  • These accounts may not be as tax-advantaged as you may think. The child’s income may be subject to the “Kiddie Tax,” which outlines the taxability of unearned income (e.g., dividends, interest, and capital gains). Generally, the first $2,100 of unearned income is tax-free, but any unearned income over that amount is taxed progressively from 10% to 37%. It might be a good idea to consider investments that are tax-efficient.
  • Any contributions to the account are considered irrevocable and subject to the annual federal gift tax exclusion limits.
  • Although you may be the custodian of the account, you do not own the assets and can only take money out to cover expenses for the child, a minor who is considered the beneficiary.
  • At the “age of majority,” as determined by your state (usually age 18 or 21), the beneficiary gains control of the account and can use the funds any way they choose. At this point, the account will likely need to be reregistered in their name. This does not happen automatically.
  • There could be a significant impact on federal financial aid eligibility as the assets in the account are considered the child’s.

If you’re considering any of these ideas, be sure to do your own research to fully understand the pros and cons of each option. Make sure to consult with your financial institution, advisor, or tax expert before taking any next steps. There are many ways to give to the children in our lives. Why not consider a gift that has returns for a lifetime?

*Withdrawals of earnings from Roth IRAs can be made penalty-free if the account has been open for five years or more and you are age 59½ or the money is used for exceptions such as qualified higher education expenses, a first-time home payment up to a lifetime limit of $10,000, certain unreimbursed medical expenses, and other situations.

A 529 college savings plan’s disclosure document includes investment objectives, risks, fees, expenses, and other information that you should read and consider carefully before investing. You should review the 529 plan offered by your home state or your beneficiary’s home state and consider, before investing, any state tax or other state benefits, such as financial aid, scholarship funds, and protection from creditors that are only available for investments in such state’s 529 plan.

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