If you’re thinking about gifting money to your child, there’s no shortage of options. You can simply transfer money into their bank account, or take a more strategic approach.
“When gifting money to children, it’s important to keep the purpose in mind. Do you want them to have fun with the money, set it aside for education or help them build lasting financial security?” says Philip Barrar, founder and CEO of FutureMoney, a micro-investment platform that allows parents to invest in and secure their child’s future.
He explains that it’s also important to consider a child’s age and maturity.
“Many wealthy families who set up trusts for their children do not fully disburse funds until their beneficiaries are well into adulthood, because it can take time to learn financial literacy and responsibility,” Barrar says.
Here’s a look at a variety of smart ways to gift money to children and what you should know about each.
Note the Annual Exclusion Limit
Before you gift anyone money, you should know about the annual exclusion limit. While the IRS does charge a gift tax, it doesn’t apply to gifts under a certain amount. In 2024, individuals can gift up to $18,000 per donee, while married couples have a combined gifting limit of $36,000 per donee.
“To the extent that any gifts exceed the annual exclusion amount, the gift tax return will report the gift and result in a partial consumption of the donor’s lifetime federal gift and estate tax exemption ($13,610,000 in 2024),” says Gary Botwinick, an estate planning lawyer and co-managing partner of Einhorn Barbarito and chair of the firm’s Wills, Trusts and Estates and Taxation practices.
Consider Financial Aid Impacts
If you have a child who may attend college in the future, you’ll also want to consider the impact that gifts will have on their ability to get financial aid from the federal government.
[READ: Kids and Taxes: 6 Tax Credits Parents Should Know About]
“An asset owned by a student is penalized in the Student Aid Index (SAI) nearly four times as much as an asset owned by a parent when filling out the FAFSA,” says David Flores Wilson, certified financial planner and managing partner of Sincerus Advisory.
He explains that it can make sense for a parent to keep a gift in their name until after college graduation to maximize financial aid eligibility.
“Parents who have already given funds to their kids might consider spending down those assets on child-related expenses like computers or college prep courses to avoid having the asset captured in the FAFSA calculations,” Wilson says.
Contribute to 529 Plans
Speaking of college, if you want to help your child pay for higher education expenses, you can gift money into a 529 plan for them.
“These plans are tax-advantaged and specifically designed for saving for education expenses,” Botwinick says. “Contributions grow tax-free, and withdrawals (including gains) used for qualified education expenses are also tax-free.”
You can gift up to the annual exclusion limit to a child’s 529 plan each year without worrying about the gift tax. Additionally, you can jumpstart the account if you’d like.
“A parent can accelerate the gift by funding the 529 plan with five times the annual exclusion in one year (a total of $90,000) but, if so, the parent would not be able to make a gift to the plan for the next four years,” says Jere Doyle, senior vice president and estate planning strategist at BNY Mellon Wealth Management.
[READ: Ways to Save for Your Child’s College Education]
If your child doesn’t end up needing the funds for higher education, plan holders can now roll over up to the maximum annual IRA contribution limit each year for five consecutive years into a Roth IRA.
“That means you can put money into a 529 plan for a child, grow it tax-free and then roll it over to a Roth IRA where it will remain tax-free until their retirement,” Barrar says.
Any other nonqualified 529 plan withdrawals, however, will be subject to income tax and a 10% penalty.
Invest in Roth IRAs
If your child is earning income — but not more than $161,000 this year — you can gift money directly into a Roth IRA in their name. In 2024, all IRA contributions are limited to $7,000 or the amount of earned income an individual makes, whichever is less.
“The funds in the Roth could be used for higher education expenses (without triggering the ‘under 59 1/2 years old’ 10% distribution penalty) or could be used to get a head start on saving for the child’s retirement,” Wilson says.
In either case, Roth IRAs offer many advantages.
“The money will grow tax-free, and the principal and any gain can also be withdrawn by the child tax-free at age 59 ½. This can be a powerful way to teach them about investing and help them save for retirement from an early age,” Botwinick says.
[Read: How to Open a Roth IRA.]
Open Custodian Accounts
If you want to gift a child money but don’t want them to have access to it until they reach the majority age in their state, a custodian account could be the right fit.
“If the goal is to give the child funds that will be managed by a parent or other relative, and the donor intends for the child to have unfettered access to the money at age 21 (or 18), the Uniform Gifts to Minors Act and Uniform Transfers to Minors Act is a great way to transfer assets to minors,” Botwinick says.
However, unfettered access at the age of 18 or 21 could present a problem for some recipients.
“This would be a time that they might not have the most prudent judgment in managing a large sum of money,” Wilson says.
Make Direct Medical and Tuition Payments
If your child needs to pay for tuition or medical bills, helping to cover them can be a tax-effective way to gift them money.
“A parent can make a tuition or medical payment directly to the education institution or medical provider and that gift will not be deemed to use up either the $18,000 annual gift tax exclusion or any of the $13.61 million estate, gift and generation-skipping exemption,” Doyle says.
He adds that the key is that you must make the payment directly to the education institution or medical provider.
Set up a Trust
If you want to gift a large amount of money and have control over how the funds are used, a trust may be the answer.
“A trust structure can be appropriate for large gifts to children given the ability to control distributions and protect the funds from creditors,” Wilson says.
Botwinick explains that trusts allow you to do the following:
— Specify conditions under which the funds can be accessed and used by the child.
— Direct when the funds will be distributed outright to the beneficiary and free of trustee control.
— Outline the disposition of remaining assets if the child predeceases the trust’s termination.
But setting up trusts can be complicated.
“This option can be prohibitively expensive and complex given the myriad parties involved including trustees, attorneys, accountants, investment managers and others,” Wilson says.
Doyle adds that they’re typically reserved for very wealthy families.
The Right Gifting Option Depends on Your Situation
The smartest way to gift money to your child will depend on a variety of factors.
“Gifting to minor children requires careful consideration of the child’s future needs, the donor’s financial goals and the tax implications of the gift,” Botwinick says.
He explains that whether it’s through savings accounts, educational plans, custodial accounts, trusts or Roth IRAs, each method offers unique benefits and considerations that are crucial to understand.
“Ultimately, thoughtful planning and, where necessary, consultation with financial and legal professionals can ensure that the gifts not only provide immediate joy and support but also lay a strong foundation for the child’s financial independence and success in the future,” Botwinick says.
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Smart Ways to Gift Money to Children originally appeared on usnews.com
Update 04/08/24: This story was published at an earlier date and has been updated with new information.
