With the holidays around the corner, many of us are getting into the gifting spirit. You might come across the perfect gift on Amazon or a great deal on a last-minute getaway.
While you won’t find much help here on those kinds of gifts, we do have important advice to share if you’re planning to give a gift of money, one of the most common and appreciated presents of all. If you’re gifting a sizeable amount of money, you need to be aware of the potential tax implications.
Under current tax law, any individual can gift up to $15,000 to another individual without incurring any gift tax or having to file a gift tax return. This is referred to as the annual gift exclusion amount. While there is nothing wrong with gifting cash to an individual directly, we want to explore some other creative ways to give a cash gift that could have a more meaningful impact in the long-term.
1. Fund a 529 plan or UTMA account for a child or grandchild
529 plan accounts are one of the most tax-efficient ways to fund future education expenses. These plans are an attractive option because their earnings are tax-deferred, and distributions are tax-free if used for qualified education expenses. Plus, some states offer an income tax deduction for contributions made to that state’s sponsored 529 plan (gifting always feels better when you can save money on taxes too).
However, if you fund a 529 plan account for an individual and they use the funds for non-qualified education expenses, then the earnings portion of the distribution is subject to income tax and a 10% penalty. You can learn more about the benefits of using 529 plans in this article.
While 529 plan accounts are oriented towards education expenses, you could fund a Uniform Transfer to Minors Act (UTMA) investment account for a broader purpose. UTMA accounts are effectively taxable investment accounts for the benefit of a minor. Similar to 529 plans, you can gift up to $15,000 per year without any gift tax consequences.
The key difference between a UTMA account and a 529 plan is that while UTMAs don’t have the same tax-deferred investment growth that 529 plans offer, UTMAs do offer more flexibility with how the funds are used if the beneficiary does not end up attending college. With UTMAs, there are no penalties for non-qualified expenses. Once a beneficiary reaches their age of majority (typically age 18, but it varies by state), they have full access to the account’s funds (i.e., it doesn’t have to be education). But be mindful about how high the UTMA balance gets over time, as the grantor no longer has any control over the funds when the recipient is old enough to gain access.
2. Fund a Roth IRA contribution for a child or grandchild
If you have a child or grandchild who is currently working and receiving earned income, consider funding a Roth IRA for them (or a custodial Roth IRA if the individual is still a minor). Under current law, any individual can contribute up to $6,000 (subject to income limits and catch-up contributions for those over age 50) to a traditional or Roth IRA, or up to an individual’s taxable income amount. For example, if your 15-year-old child earns $3,000 of taxable income working as a lifeguard over the summer, they could contribute up to $3,000 into either a traditional or Roth IRA.
Funding a Roth IRA instead of simply gifting cash to a child or grandchild can be a great long-term investment because the money in a Roth IRA can grow tax-deferred, and when your child or grandchild pulls money out of that account down the road in retirement, those distributions are completely tax-free.
3. Directly pay for medical or education expenses
The key word here is directly. If you have a loved one who is either currently in school or facing a large, looming medical bill, you can directly pay that medical or educational institution. By directly paying the institution, whatever funds you pay are gift-tax free and are not subject to the $15,000 annual gift exclusion described earlier.
4. Apply “purpose” to a cash gift
If you do want to gift cash outright to an individual, consider assigning a purpose to that gift. A few examples could include gifting cash for a car purchase, down payment on a home or payoff of an outstanding student loan. Applying purpose to a gift can help make the gift feel more meaningful to the recipient.
5. Have the gift recipient help you choose a charity for a donation
Admittedly, this one’s a little different, but just as meaningful as the other strategies we’ve talked about. To foster charitable giving by a loved one, consider asking them to help you choose a cause to donate to. Ask your kids to do research on a charitable organization with a mission they care about. Then, have them make a case for why that organization should receive a donation. This is a great way to help your children or grandchildren attach value to those funds being gifted, and it can also be a great way to educate them on finances.
Contact us to learn more about how we can help you make the most out of your gifting.