Are you a parent or grandparent who wants to make a financial gift to a minor child? Do you want to help fund a child’s education but aren’t sure if that’s the path they’ll take? Do you want to give your children a financial head start in life so that one day they can start a business, buy a home, or cover basic health and living expenses?
An integral function of most estate plans is the transfer of wealth to future generations. But rather than waiting until death to transfer assets, there may be tax benefits to giving while you’re living.
If you have sufficient wealth to cover your needs and then some, a lifetime gifting strategy could make sense from an estate and tax planning perspective, as well as have a significant impact on your descendants’ quality of life.
Tax-free gifting opportunities
Under current law, in 2021, the lifetime gift tax exemption allows individuals to gift up to $11.7 million ($23.4 million for married couples) without paying gift tax. In addition, the annual gift tax exclusion allows you to make tax-free gifts, each year, of up to $15,000 per individual (or $30,000 from a married couple) to any number of gift recipients, without having an impact on your lifetime gift tax exemption.
The current tax law also allows certain gifts to be made that don’t count against these gift and estate tax exemptions.
For those with the ability and desire to give, a wealth management plan that involves optimizing the lifetime exemption, annual exclusion gift limits, and/or other “exempt” gifts can be a very simple and effective tax-saving strategy over time.
There are several gifting strategies that can be used to optimize lifetime gift exemption and gift tax exclusion amounts:
Direct payment for medical and educational expenses. Gifts in the form of direct payments for medical and educational expenses are not subject to the annual gift limit and are not counted against your annual or lifetime exemption amounts.
With a direct payment, you can be confident knowing that your gift was used for a specific purpose (education or healthcare) and that you were able to help relieve your loved one of a financial burden. However, gifts made as direct payments are irrevocable, can only be used for certain qualified expenses and may impact a child’s financial aid award.
529 college savings plans. A 529 college savings plan is like a retirement savings plan, but for education. The main advantage of a 529 plan is that the money invested can grow free of federal income tax. However, under federal tax rules, the money must be used for qualified higher-education expenses, such as tuition, books, and room and board. Although, in some states, up to $10,000 per year can be used for K-12 education.
A unique benefit of the 529 plan is that you can front-load the account with up to five years of your annual exclusion gift all at once. By front-loading instead of spreading the gifts over five years, you’ll have a larger initial pool of money to invest and potentially grow over time. If you choose to front-load, it’s important to note that you will be prohibited from making annual gifts to that recipient for that five-year period.
UGMA and UTMA custodial accounts. UGMA (Uniform Gift to Minors Act) and UTMA (Uniform Transfer to Minors Act) accounts are custodial accounts. They are like trusts in that they hold and protect assets for minors until they reach the age of majority, but without the actual creation of a trust.
Custodial accounts are similar to individual bank or investment accounts, except that an adult custodian holds title and control of the account for the benefit of the minor until he or she reaches the age of majority. Until then, the custodian has the authority to invest and withdraw funds for the benefit of the child, while any income earned by the account is generally taxable to the child.
Custodial accounts have a few drawbacks. For example, if the donor is also the custodian of the account and dies before the property is distributed to the minor, the property will be included in the donor’s estate. In addition, gifts to custodial accounts are irrevocable. Furthermore, once the child reaches age 18 or 21, the account is transferred fully to the child, which may be a concern if you do not believe the child has the ability to manage the account wisely.
2503(c) trust. The purpose of a Section 2503(c) trust—also called a minor’s trust—is to gift money to a minor without giving him or her immediate access to it, while ensuring that the gift qualifies for the annual gift tax exclusion amount.
As with other trusts, a 2503(c) trust has a trustee. The trustee has full discretion over distributions, as long as they serve the “comfort” and “welfare” of the minor. Also, if the minor passes away before reaching the age of majority, the trustee must distribute the remaining assets to the minor’s estate.
Like custodial accounts, 2503(c) trust assets must pass to the beneficiary once the child reaches the age of majority, which could be problematic if the donor believes the child isn’t ready to handle the responsibility.
Crummey trust. A Crummey trust could be a good option for gift donors who want to allow more flexibility for distributions, have more than one beneficiary or want to delay distributions beyond the age of majority.
However, administering a Crummey trust is typically more complex than other gifting methods, as annual reporting and notifications are often required.
A qualified trust and estate planning professional can help you determine the best gifting strategy for you based on your individual goals and financial circumstances.
CIBC Private Wealth’s Wealth Your Way podcast series is an educational offering for clients and their children, and demonstrates our commitment to developing the rising generation. Listen to the podcast on gifts to minors here. There, you will also find other informative podcasts that are designed to help rising professionals steer through their personal financial journeys.