The ins and outs of gifting money to children

The ins and outs of gifting money to children

Whether you’re a generous parent or a loving aunt or uncle, there are laws about how you can gift money to children. Family members and friends who want to give kids a great financial head start can positively influence a child’s life. However, the way you gift money to kids can also impact your finances. It’s important to understand all the rules and regulations around gifting money to children, so you don’t end up on the wrong side of being generous.

Make the right preparations first

Before gifting money to children, it’s essential to understand your goals for your gift and the child. Do you want them to spend your financial gift now? Would you like to contribute toward their future college education or help them build wealth? How you gift money is up to you, but make the right preparations first by clarifying your gifting goals. Consider the following tips to make sure your gift will be well received.

Teach kids the value of money

Before any child can appreciate your financial gift, they need to have a degree of financial literacy to understand what money can do for them. Gifting money to children can be a great way to introduce the value of money and how it helps us buy things we need and want. Talk to children about the difference between needs and wants, and explain how money can help them meet needs, wants, or both.

Explore non-cash financial gifts

Cash for kids can be tempting to spend, so if your goal is for children to use your gift toward a future goal, explore non-cash options. Handing a child $50 can be a fun shopping experience, but buying your loved one $50 in stock is a gift that will grow with them for years to come. Consider non-financial gifts like: 

  • Stocks 
  • Bonds
  • Deposits in a custodial fund
  • Contributions toward future education
  • Savings account deposits

Set clear expectations 

When gifting money to children, make sure they understand how they can use your gift and what it’s for. If you’re unsure what kind of financial gift to give or want to provide more options for your child, give a set number of gift options or choices for what they can do with your monetary gift. 

What to keep in mind when gifting money to children

Once you know how you want to go about gifting money to children, look out for any financial implications that might come with your gifting. Keep the following considerations in mind as you give:

  • Remember that your yearly, tax-free gift amount is capped by the IRS. Gifting money to children can be tax-free, but the IRS sets a limit each year on how much you can give. The maximum gift tax exclusion sets the amount you can give without paying taxes federally, which can change year-to-year. 
  • Tuition, medical, and dental costs are excluded from said cap. If your financial gift goes toward medical or dental bills, or if you’d like to help a child pay tuition, these gifts can be exempt from the above gift tax exclusion max. However, to be excluded, these expenses must be paid directly to the doctor, dentist, or school. Research any rules around your specific giving situation and talk to an expert before making any financial decisions. 
  • You have more giving room with a 529 college savings plan. There are special rules in place when contributing to a state-sponsored 529 plan. They aren’t exempt from the gift tax limit, but you can lump contributions together for up to five years. College savings plans have their own rules and regulations, so research your child’s plan. 

Related: Grants, Scholarships, Loans, and More: How to Save and Pay For College

  • Don’t run afoul of the Kiddie Tax. In an effort to make sure parents don’t gift stocks to kids to avoid paying taxes, there are laws in place about ways to gift stocks to children under 24. If you gift your child shares where the amount of interest or dividends exceed $2,000, you’ll pay the taxes at your highest rate. 
  • Understand the IRS’ lifetime gift exclusion. There are limits on how much the federal government allows you to give away tax-free in your lifetime. While the limit is high, $12.06 million in 2022, each year’s financial gifts are subtracted from your total lifetime gift exclusion. Know how your financial gifts will impact your estate planning and financial future. 

How to gift money to children

1. Set up a UGMA custodial account

A popular choice for gifting money to children is setting up a UGMA custodial account. The Uniform Gift to Minors Act law sets the rules for these accounts where parents, family members, and friends can set up and contribute to a child’s future. 

2. Establish a 529 college savings plan

If your goal with gifting money to children is to help them pay for their college education, consider a 529 plan. These accounts allow you to contribute toward any child’s education with special benefits to the giving party. 

3. Set up a trust

Trusts can make an excellent tool for parents or family members to give financial assets to kids. Trusts can help you transfer wealth or give many kinds of financial gifts with tax advantages. A trust is more work to set up than a typical UGMA custodial account, but depending on your financial situation, it could be the best option for you. 

4. Add contributions to a Roth IRA

Contributing to a child’s Roth IRA is a gift that will continue giving for decades. Any contributions made now will compound for years, and the child can withdraw their money tax-free in retirement. Small amounts in a retirement account now make tremendous financial gifts later. 

 

Related: Investment Accounts for Kids: Where to Start

5. Just give cold, hard cash

Sometimes it’s nice just to give a child cash. A small amount of cash alone, or in addition to a non-cash gift, can create a fun opportunity for kids to buy something they really want or need. If a child has a set financial goal, giving cash may be the best way to help them accomplish it and teach them valuable lessons about saving money.

FAQs

Does gifting money to kids affect Medicaid? 

Gifting money to children can affect their eligibility for premium assistance, especially if given in large amounts. Gifted money is considered unearned income, and how your gift impacts the child’s assistance will depend on your state’s Medicaid program. Check with your state’s program authorities for more information. 

Can kids do what they want with their money gifts?

Once you gift money to a child, it becomes their money to do with as they’d like. Cash or assets given to a child become the child’s property. A non-cash strategy can help control where your gifted money goes, especially if you contribute directly to a college savings plan or custodial account. While the child owns the funds, there are set limits on what they can do with different types of accounts.

What’s the right IRS form to use to gift money to children?

You’ll need to report gift taxes on IRS Form 709

 

 

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Written by GoHenry Published Dec 16, 2022 ● 6 min. read