Are you trying to find the perfect gift for your children, grandchildren, nieces, or nephews this season? Instead of getting clothes they’ll outgrow or a toy or gadget that’ll be forgotten, why not give a financial gift this year?
I don’t mean cash or a gift card. I’m talking about college tuition, retirement savings, individual stocks, mutual funds, or a bank account. Something that can make a difference and teach a lesson simultaneously.
Knowledge is power
Even if I, like most men, don’t read directions, they are essential. What about the directions for the financial gift? That should be the goal, even if the receiver doesn’t realize it. Use the opportunity to become a wise financial grasshopper.
Make it a fun project to track progress. Whether it’s savings, performance, gains, risk, losses, or budgeting, you’re laying the foundation for financial common sense that can be carried through life. You’re teaching Finance 101.
Hold on, don’t get your checkbook out yet. Please read my post Understanding the Gift Tax, before you forge ahead with financial gifts. While it’s not as complicated as many believe, there are rules you must know before you give the gifts that keep on giving.
The gift of college tuition
You constantly hear about the plight of recent graduates and some not-so-recent graduates carrying loans for years. Tuition is a great gift for any occasion.
529 plans are the most popular education savings tool for a reason. Ease of use, tax-free benefits, multiple options, and in many states, you can also get a state income tax deduction. To learn more about 529 plans, please read Know the Rules When Using a 529 Plan and 7 Frequently Asked 529 Questions.
529 plans are counted toward financial aid as a parental asset. That is more favorable than student-owned assets in the financial aid equation. There is a way to avoid having 529 plans counted towards financial aid – grandparent-owned 529 plans.
Yes, grandparents can own 529s for their grandchildren, and it doesn’t count towards financial aid, AND they may be eligible for a state income tax deduction depending on their state.
One warning, when distributions are made from a grandparent-owned 529, they are counted as income to the beneficiary. That would affect financial aid for the following year, so it’s best to use a grandparent-owned 529 plan for the last year or so of college.
The gift of investing
One of my favorites is teaching about investing, the gains, losses, risks, and performance. You can purchase individual stocks from a company and get into the dividend reinvestment plan. Make it fun! Purchase stock in a company they know. Help them follow and learn about the ups and downs of investing. Mutual funds work as well and help with diversification.
The gift of retirement
Who wouldn’t want the gift of retirement? I’d take that. Do you have teenagers or young adults who have earned income? They, with your help, can open a traditional or Roth IRA. They could contribute $6,500 (2023) or the total amount of their W-2 income per year if they earned less.
Johnny is 16 and works at the local supermarket. He started in June and made $2,000 during the year. Johnny can contribute up to $2,000 to an IRA.
The funds to be deposited into the IRA can come from you as a gift. Not a bad start for Johnny. As a bonus, these accounts are not counted in the financial aid equation and aren’t subject to the kiddie tax since they are qualified accounts.
The gift of savings and checking accounts
Borrrinngg! Boring is good. Savings is good. Budgeting is great. A savings account should be opened for kids when they’re still in diapers. Start’em saving young. A checking account should be opened for teenagers when they get their first job—a great time to teach them budgeting.
No, it’s not all rainbows, unicorns, and butterflies regarding gift giving. There are two significant risks to watch out for. First, your intentions versus the behavior and decisions of the receiver are not always the same. Second, even though it’s easy to avoid the gift tax, other taxes and financial consequences must be planned for.
When you give a gift, you lose control over it. You cannot make someone wear that ugly sweater or tacky tie, and you can’t put conditions on financial gifts, although you can try. Financial gifts can be abused, misused, or wasted. That, unfortunately, is the prerogative of the recipient of the gift. That’s where financial mentoring comes in.
Use common sense to match the size of the gift to the recipients age and maturity
Yes, there are ways to control financial gifts, but if you have control, it’s not technically a gift. You’re dangling a future gift like a carrot – and that’s not always bad. Unless that gift is in a trust (future post) or a 529 plan where they are not the owner, just the beneficiary, they will do whatever they wish in the end.
Use the gifts as stepping stones to increase financial knowledge and responsibility.
Capital gains tax: If you’re thinking of gifting stock you own, be careful, especially if the stock or any asset you want to gift has appreciated.
Granny bought 100 shares of XYZ Co. years ago. Today the stock has a fair market value of $10,000, but her cost basis is only $1,000. She gifts the stock to you, and your basis is her basis of $1,000. If you sell the stock, you’ll pay capital gains tax on the $9,000 gain.
If, instead, she left you the stock in her will and the day she passed, the value of the stock was $10,000, that would be your new basis. It’s called a step-up. If you sold the stock a month later for $10,500, there would be a $500 gain. It is less taxing that way.
Financial aid: Depending on the amounts and how they’re given, there could be financial aid considerations. Assets in the student’s name are not suitable for financial aid.
Kiddie tax: This prevents parents from moving unearned income to their lower-taxed children. Children pay tax at their income tax rate on unearned income up to $2,500 (2023). The unearned income they receive above that amount is taxed at their parent’s highest income tax rate. This only applies to unearned income, such as stocks, bonds, real estate, or mutual funds.
The kiddie tax applies to the following:
- children under 19 years of age, and
- children aged 19 through 23 who are full-time students and whose earned income does not exceed half of the annual expenses for their support.
Gifting can be a tricky business. It’s best to talk to your advisor and get a plan in place. Again, I believe the best course of action is to use common sense, start small, and be a financial mentor. It’s more effective to watch your gift grow from a tiny seed and turn into something bigger than providing a significant gift and walking away. It’s not the amount you give but the guidance you provide.
If you have any questions, feedback or want to know how to become a financial mentor, contact me or leave a comment below.