As parents or grandparents, we want to do what’s best for our children and grandchildren. We want them to enjoy the gifts we’ve given them during our lifetimes – family traditions, connections and values – and we also want our financial legacy to pass to them without complications. But if we don’t manage our gift planning thoughtfully, we could leave future generations with unexpected challenges.
In my practice, I’ve seen many ways for individuals to transfer wealth from one generation to another, but to my mind, there are just a handful of vehicles that effectively transfer financial gifts for future generations during our lifetimes. My top recommendations are UTMA/UGMA accounts, 529 accounts, IRAs and irrevocable gift trusts.
Which of those options you should choose will depend on the degree of control you wish to retain, the purpose of your gift, and the amount of the planned gift. Let’s review the pros and cons of these various models so that we understand how to work with legal and financial advisers to provide for our heirs.
UTMA/UGMA Accounts
The simplest method of gifting involves setting up a custodial account under your state’s version of the Uniform Transfer to Minors Act or Uniform Gift to Minors Act. These accounts exist for the purpose of allowing gifts to be set aside for minor children who otherwise could not legally own significant property. Custodial accounts allow you to designate someone (including yourself) to manage gifted funds until the child is of age, most commonly 18 or 21.
The upside of this approach is that it takes almost no effort to set up such accounts. The accounts contain standard provisions in accordance with local law, and they are as easy to create as asking your bank to set up a custodial account for you.
Custodial accounts, however, are considered taxable to the child. This could complicate matters if investment income triggers a “kiddie tax,” potentially making the child’s income taxable at an even higher rate than their parents’ and in line with income tax brackets for non-grantor trusts. As concerning as the federal tax is, keep in mind that your state might have a lower threshold that also could trigger a state “kiddie tax.” Talk with your attorney or tax adviser about these issues before setting up a custodial account.
An even larger downside of custodial accounts is that once the child attains the age of 18 or 21, that account becomes theirs, period. If you plan to make a large gift or a number of gifts, this could mean that a beneficiary as young as 18 wakes up one day with immediate access to a small fortune. How and whether that fortune is managed and …….