Gifts are another effective way to pass your assets along to your survivors – tax-free. Through a carefully planned program, you may be able to "gift" your assets to whom you want and to save significant taxes in the process. The advantages and disadvantages of gifting money in this way are as follows:
Advantages of gifting assets
- Because of the Annual Gift Tax Exclusion, you may give up to $11,000 every year to each of your children (or to anyone else) without incurring a gift tax. As a couple, you can give $22,000 to each child (or anyone else) without any gift tax liability. All gifts that fall within these limits are protected from federal gift and estate taxes, making this one of the easiest ways to reduce the size of your taxable estate and build a nest egg for your children's future. And gifts can be given while you are still alive so you can ensure that your assets go exactly where you intend them.
- Gifts are a private matter. Whereas the contents of your will often become a public record in the probate court, gifts remain behind closed doors.
Disadvantages of gifting assets
- Gifts are irrevocable – which means that you can't take any money back once it has been given. Also, you can't control how your children use the money they have been gifted once they come of age. To prevent your children from spending the money at a young age, you might want to appoint a legal guardian to handle their money.
- Also, once you "gift" assets to a child, you typically can't use income from these assets (see UGMA) to pay for a child's basic necessities. The reason for this limitation is that the government views taking care of your child as a legal obligation of you as a parent, rather than your child's obligation.
Uniform Gift to Minors Accounts (UGMA)
One way to avoid the need to appoint a guardian and to not give money to a child until the age of eighteen or twenty-one (depends on state law) is to transfer the money into an account under your spouse's name as custodian for your child. Such custodial accounts are known as Uniform Gift to Minors Accounts, or UGMA, accounts.
Income from interest, capital gains, and dividends is taxed at your child's rate. This rate is typically lower than your own, unless your child's under fourteen, in which case he or she would be taxed at your rate until the child reaches fourteen years old (this in known as the Kiddie Tax).
When your child reaches the age of eighteen or twenty-one (depending on the state), he or she is legally entitled to the funds in the account and can do with them what he or she pleases. (Note that UGMA is now known as UTMA (Uniform Transfer to Minors Act).
Alternatively, consider a trust . . .
Under this alternative, you would create a trust for your child and transfer $11,000 (if you are single) or $22,000 (if you are a couple) each year to the trust tax free. To clarify, there is no cap to what you can contribute to the trust but you will pay taxes on any gift above $11,000 for singles and $22,000 for couples. You will need an attorney to draft the special provisions necessary to permit the gifts to qualify for the annual exclusion rule and avoid taxes. A trust allows you to specify when your child will receive the funds and how much he or she will be able to access -- rather than leaving that decision up to the UGMA rules that give the funds to the child at age eighteen or twenty-one, depending on the state. Thus, you can require the assets to be held in a trust until your child reaches certain ages (say, fifty percent at age twenty-five and fifty percent at age thirty) or until he or she gets married.
HerTip: Qualified State Tuition Programs (QSTPs), or 529 plans, have become an increasingly popular and available vehicle to help families fund the rising cost of education. What's more, there are significant tax advantages to saving for a beneficiaries' education. Learn more here.
Continue to: Part IV: Wills and testamentary letters
*WFN at Siebert and Muriel Siebert & Co., Inc. do not provide tax or legal advice.
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