Three Ways Parents Can Transfer Wealth to Help Their Kids
From custodial accounts to trusts, Baby Boomers can take part in the great wealth transfer in ways that won’t burden their kids with extra taxes.
Editor’s note: This is part two of a three-part series aimed at helping parents and their children manage generational wealth. Part one is Four Ways Parents Can Help Kids Be First-Time Home Buyers.
We are in the midst of a great wealth transfer. Baby Boomers who have built their wealth are now looking to help their children get a head start financially. As the next generation begins to accumulate wealth of their own, financial and wealth planning solutions and strategies also need to evolve.
In the first article of this series, I addressed how parents can help their children be first-time home buyers. This article discusses strategies parents can use to assist the next generation with a financial head start that are beyond the typical direct gifting of cash.
Sign up for Kiplinger’s Free E-Newsletters
Profit and prosper with the best of expert advice on investing, taxes, retirement, personal finance and more - straight to your e-mail.
Profit and prosper with the best of expert advice - straight to your e-mail.
Custodial accounts
When a child is young, parents often open a custodial account on the child’s behalf, also known as either UTMA (Uniform Transfers to Minors Act) or UGMA (Uniform Gifts to Minors Act) accounts. Parents typically open these accounts as a convenience to accumulate birthday and holiday cash gifts that a child receives.
While the child is young, the custodian named on the account controls the assets and is charged to use the money for the benefit of the child. However, when custodianship is set to terminate, which typically occurs when the child attains an age between 18 and 25, depending on state law and the purpose for which the account was established, the legal control transfers to the child.
While many young adults would welcome a sudden inflow of cash in their own name, it is often not desirable for the child to have immediate use and control over the funds, especially if the account is sizable, as some of these accounts can be with accumulation and growth over time. In those cases, it may be wise instead to consider using alternative structures, such as a trust or an entity like a limited liability company or limited partnership, to transfer the custodian account assets, as opposed to them passing to the children outright at the prescribed age.
If done properly, these alternative structures can provide some additional controls over the funds and, in some cases, a degree of creditor protection. It is important to note that these alternative strategies are heavily dependent on state law and the specific facts and circumstances of the situation. Therefore, careful consideration should be given well in advance of the child attaining the age of control. In all cases, consultation with an attorney well versed in the local state rules can be critical.
Another alternative would be to forgo the custodial account strategy altogether and use a trust structure from the get-go if the expected gift amount is expected to be sizable, or there are individual circumstances to consider.
Funding education and medical expenses
If a parent finds a child in need of help when it comes to education expenses or medical bills, a natural inclination may be to write the child a check. For high-net-worth individuals where estate tax and gift tax may be an issue, a more efficient way to help a child with these types of expenses may be to directly pay the education or medical institution. That is because any gratuitous transfer of funds is considered a gift that could be subject to a federal gift tax unless it’s either within the annual gift tax exclusion amount (currently $17,000 per recipient per year) or the lifetime gift exemption amount ($12.92 million per individual over one’s lifetime).
As such, any money given to a child, regardless of the usage, would be considered a gift and potentially be subject to gift tax. An exception to this rule is under the qualified transfer rule of Section 2503(e) of the Internal Revenue Code, which provides that direct payments on behalf of another individual for tuition or medical expenses is excluded if it is paid directly to the provider. For example, if a parent were to write a check to the child, who then deposits the funds in her own account and then uses that money to pay her college tuition bill, that would not quality for this exception.
If instead the parent were to pay the child’s tuition directly to the college on behalf of the child, the tuition payment would qualify for this exception and therefore not be subject to gift tax. Further, the tuition payment would not reduce the parent’s available annual exclusion or lifetime exemption amount. This strategy allows the parent to maximize the available ways one can make a gift-tax-free wealth transfer to the next generation.
It is important to note that this only applies to tuition and excludes fees for books, supplies, dormitory fees and room and board.
Trusts
If a child is fortunate enough to be a beneficiary of a trust fund, there may be a natural inclination to make distributions of cash from the trust to assist the child financially. There may even be a desire to terminate the trust early once the child is an adult and has demonstrated an ability to handle the money responsibly.
While this is certainly a common use of a trust, one ought to examine the situation more holistically before making such distribution or termination decisions.
First, cash distribution is not the only way a trust can be used to help a beneficiary. A trust may be used to purchase assets on behalf of a beneficiary. For example, if a child wishes to buy a first home, instead of making a cash distribution to the child, the trust may buy the home as the property owner, and the child, as the beneficiary of the trust, can live in that home rent-free.
This way, the home remains an asset of the trust and would be afforded the same creditor protection as other assets held in that trust. This can especially become helpful down the road if the child were to run into creditor issues or ended up getting a divorce.
Second, there could also be a tax benefit of keeping assets in a trust. If the child is successful in her own right and does not need the assets in the trust for living expenses, it may be better to let the assets stay in the trust for the duration of the child’s life. Any assets remaining in the trust held for the child’s benefit would not be includable in the child’s own estate for estate tax purposes at her death, and assuming the trust instrument provides for a longer duration, assets remaining in the trust could pass to the next generation. This of course depends on the terms of the original trust instrument.
If the trust instrument does not allow for such an extension of terms, then in certain circumstances, a modification to the trust may be possible.
This area can be complex, requiring careful legal analysis, but it’s often worth the extra work if you look at wealth from a multigenerational perspective.
The changing new generation of wealth requires shifting wealth planning solutions. In the next article of this series, I will address the “human” side of the wealth transfer equation — how to educate and teach young adults about the responsibility of managing wealth.
Wilmington Trust is a registered service mark used in connection with various fiduciary and non-fiduciary services offered by certain subsidiaries of M&T Bank Corporation. Note that tax, estate planning, investing, and financial strategies require consideration for suitability of the individual, business, or investor, and there is no assurance that any strategy will be successful. Wilmington Trust is not authorized to and does not provide legal, accounting, or tax advice. Our advice and recommendations provided to you are illustrative only and subject to the opinions and advice of your own attorney, tax advisor, or other professional advisor.
related content
To continue reading this article
please register for free
This is different from signing in to your print subscription
Why am I seeing this? Find out more here
Alvina Lo is responsible for family office and strategic wealth planning at Wilmington Trust, part of M&T Bank. Alvina was previously with Citi Private Bank, Credit Suisse Private Wealth and a practicing attorney at Milbank, Tweed, Hadley & McCloy, LLC. She holds a B.S. in civil engineering from the University of Virginia and a JD from the University of Pennsylvania. She is a published author, frequent lecturer and has been quoted in major outlets such as "The New York Times."
-
How to Help Your Kids Without Ruining Your Retirement
Here are some general considerations to ensure the gift of assets to your kids will not negatively affect your financial future.
By Mario Hernandez Published
-
AI to Power the Next Generation of Robots
The Kiplinger Letter There's increasing buzz that the tech behind ChatGPT will make future industrial and humanoid robots far more capable.
By John Miley Published
-
How Annuities Can Help You Retire Early and Delay Social Security
Waiting until 70 to claim Social Security benefits can pay off, so how do you bridge the gap between giving up your paycheck and filing for benefits?
By Ken Nuss Published
-
How to Get Your Kids to Step Off the Gravy Train
A surprising number of young adults live with their parents. Setting some financial ground rules could get the kids out on their own faster.
By Neale Godfrey, Financial Literacy Expert Published
-
Spring Is a Good Time to Clean Up Your Finances, Too
While you’re decluttering your home for spring, consider taking a crack at cleaning up your finances and old paperwork, too.
By Tony Drake, CFP®, Investment Advisor Representative Published
-
Is Your Retirement Solution Hiding in Plain Sight?
Here’s how to use your home equity in combination with an annuity contract to produce late-in-life income.
By Jerry Golden, Investment Adviser Representative Published
-
How to Choose Your Trustee or Executor of Your Will
Above all, you should choose someone you trust, keeping in mind that acting as a trustee or executor can be a complex, thankless and sometimes long-term job.
By John M. Goralka Published
-
Three Steps for Women to Take Control of Their Finances
These strategies are especially for women who are new to managing their money because of divorce or the death of a spouse.
By Emily Glassman Published
-
How AI Can Help Take the Emotion Out of Investor Decisions
AI-driven recommendations can complement human judgment, leading to more rational choices that aren’t as influenced by biases and blind spots.
By Francis Geeseok Oh Published
-
Can You 1031 Exchange into a REIT?
No, you can't, but two other REIT-like alternatives let you defer capital gains taxes while giving you exposure to institutional-quality real estate assets.
By Daniel Goodwin Published