How to give money to your kids

Steve Merrell |

 Q: My wife and I would like to give some money to our children to help them prepare to inherit our wealth, but we aren’t sure how to best do that. I read somewhere that my kids could have Roth IRAs. Any ideas?

A: I don’t know if there is a single right way to give money to children, but I do know there are a lot of wrong ways. So much depends on the personality of the child and the dynamics of the family. I encourage you to work closely with a trusted wealth manager—someone who can help you design a program specifically for your situation.

I know a wealthy Silicon Valley couple who did an excellent job training their son to inherit wealth. Over the years, they encouraged him to have a job and save his money. Shortly after he graduated from a rigorous college program, they felt he was ready to take the next step. After carefully considering their son’s readiness, they sat down with him and said, in effect, “Son, as you know we have been blessed with significant success. Next month, we are going to transfer $200,000 into your account. You can do what you want with it, but please understand: if you manage it responsibly, significantly more money will come your way over the years. However, if you waste it and show no personal ambition, this is all you will ever get.” With their encouragement, the son bought a few necessary items, then hired a wealth manager, invested wisely and learned the lessons his parents needed him to learn.

What can we learn from this family’s experience? First, make sure you have a clear understanding of what you are trying to accomplish with your gift. Second, be careful to match your gift to your children’s abilities. Finally, establish clear expectations about your gift with your children. Carefully doing these three things will help make your gift a significant blessing in your children’s lives.

Roth IRAs are an excellent way to give money to children. Because Roth IRAs are funded with after-tax dollars, any growth and all future withdrawals are tax-free. These tax benefits are especially beneficial in helping minor children escape kiddie tax issues.

Roth IRAs are also extremely flexible. Beginning five years after the Roth IRA is established, Roth IRA owners can tap into their accounts anytime without penalty.  This is a great advantage for young people who at some point may want to buy a home or make some other important purchase.

Roth IRAs face some significant restrictions, however. The first is that your child must have earned income. The second restriction is that Roths have annual contribution limits. For 2019, the limit is the lesser of $6,000 or the account holder’s earned income.

If you are unable to contribute to a Roth IRA, your children may benefit from you opening a 529 plan account in their behalf. Like a Roth IRA, the money in a 529 plan grows tax-free and all withdrawals will be tax- and penalty-free as long as they go to pay for qualified education expenses.

529 plans are also good if you want to give a lot of money quickly. IRS rules allow spouses to split gifts, meaning both you and your wife could each donate $15,000 per year ($30,000 total) to each child without being required to file a gift-tax return. On top of that, 529 plans allow you to front-load five-year’s worth of contributions in the first year. That means you and your wife together could potentially give as much as $150,000 to each of your children into their 529 plan accounts. Please note that if you front-load, you cannot make additional contributions (or take money out) until the five years is over. 529 plans allow you to stay in control of the money while designating that the money is meant to benefit a specific child.

You might also consider setting up Uniform Transfer to Minors Act (UTMA) accounts for your children. But be aware that UTMA accounts have no special tax benefits and you have no control over the assets once the children reach 21 years of age and the account reverts to their control.

 

Steven C. Merrell  MBA, CFP®, AIF® is a Partner at Monterey Private Wealth, Inc., an independent wealth management firm in Monterey.   He welcomes questions you may have concerning investments, taxes, retirement, or estate planning.  Send your questions to: Steve Merrell, 2340 Garden Road Suite 202, Monterey, CA  93940 or email them to smerrell@montereypw.com.