5 Tax-Efficient Ways to Share Wealth with Kids

Have you thought about how your taxes could affect your child’s financial future?

Parents and grandparents are always seeking to do what’s best for their children and grandchildren. They want them to enjoy the gifts they’re given during their lifetimes. This includes family traditions, connections, and values.

But they also want their financial legacy to pass down to them without any complications. In order for this to happen, it’s crucial that they lay the proper foundation and pass down the right financial gift to your children without any interference.

If we don’t manage our wealth responsibly, we risk leaving our future generations with unexpected difficulties. Luckily, we found some tax-efficient ways that are the most convenient means of transferring wealth from generation to generation.

Here are 5 ways you can share the wealth with your kids!

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General Trusts

The most universal way to share the wealth with your children is by establishing a trust fund. There isn’t a one-size-fits-all strategy to this, and the tax rules can change and be hard to understand. That’s why many people choose to steer clear of them.

One thing’s for sure, though… they should always be set up using a trust or estate attorney. In a nutshell, a trust is a private agreement that names a trustee who’ll manage property for one or more beneficiaries. The terms of the contract can be almost anything you want.

And depending on state law, trusts can be set up to be fully asset-protected for a beneficiary’s lifetime. This will provide broad flexibility, allowing assets to be used for something as specific or varied as you’d like.

Unlike standardized custodial and other accounts, there’s no set age or conditions for a beneficiary to be able to obtain full access and control of their fund. But this decision is left entirely up to the person who created the trust.

That person can likewise decide what happens to funds remaining after the passing of a beneficiary instead of letting them make that decision.

UTMA And UGMA Accounts

The simplest method of sharing your wealth is to set up a custodial account under your state’s Uniform Transfer to Minors Act or Uniform Gift to Minors Act. These accounts allow gifts to be set aside for minors who otherwise couldn’t legally own significant property.

Custodial accounts enable you to designate someone, including yourself, to manage gifted funds until the child is 18 or 21. The upside of doing this is that it takes almost no effort to set up such accounts.

They contain standard provisions following local law and are easy to create. Just ask your local bank to set up a custodial account for you. Just remember that this kind of account is considered taxable to the child.

This could complicate things if investment income triggers a “kiddie tax,” making the kid’s income taxable at a higher rate than their parents. Regarding the federal tax, keep in mind that your state might have a lower threshold that could also trigger a state “kiddie tax.”

Before setting up a custodial account, talk to your attorney or tax adviser about these issues. A more significant downside of custodial accounts is that once the child turns 18 or 21, that account becomes theirs, period.

If you plan to give them a large gift, this could mean that someone as young as 18 wakes up one day with full access to a small fortune. Is this your intention? Even if the child can’t manage the assets, the account must still be used for their benefit.

Failure to adhere to this rule could subject the custodian to a lawsuit alleging that the account was mismanaged on the minor’s behalf.

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Grantor Retained Annuity Trusts

Trusts are some of the most beneficial ways you can contribute gifts to the minors in your family. Specifically, Grantor Retained Annuity Trusts will allow you to transfer whatever assets you want to your child in a tax-efficient manner.

There isn’t a specific way of creating the trust, but there ARE certain tax rules you’ll need to follow. Furthermore, trusts generally involve the law with a few complex tax procedures that are hard to grasp. That’s why we suggest hiring an attorney or estate agent.

The textbook definition of a Grantor Retained Annuity Trust is “a confidential agreement that names a grantor to manage annuity payments on behalf of the beneficiary until they are of the legal age.”

The disadvantage to this method is that the grantor has to see the GRANT term to the end.

529 Plans

529 plans are an increasingly popular way of passing on your wealth to the following generation. The main PURPOSE of a 529 account is for your gifted funds to be used for educational purposes, but note that there is a laundry list of expenses that qualify as “educational expenses.”

Therefore, you must familiarize yourself with what a 529 plan distribution can do for you. Now, the principal BENEFIT of a 529 is that any income from transfers into the account is free of any federal income tax, as long as distributions are used for qualified expenses.

A 529 account allows you to designate who will manage the funds, keeping beneficiaries from having direct control over that money. This means the beneficiaries never have an absolute legal right to receive these funds.

From a tax viewpoint, contributions to a 529 account still qualify for the annual gift tax exclusion.

Nevertheless, they provide additional gift-and-estate-tax planning options, like allowing you to make front-loaded gifts for up to five years without having to use your lifetime estate tax exemption.

Another significant benefit of a 529 account is that you can change the account’s beneficiary, providing flexibility as other children or grandchildren are born.

Overall, a 529 plan account is a great tool for those who wish to save for their kids’ or grandkids’ educational expenses, offering the convenience of a single plan that can be used for your entire family.

Crummey Trusts

This trust is named after Clifford Crummey, who was the first to use this type of approach successfully. The Crummey trust allows parents to make contributions on behalf of their children.

Furthermore, parents are entitled to make annual gift exclusions, and they can decide when and how their children can access these funds.

This sort of trust protects your assets by allowing the grantor to develop certain conditional requirements for when your child can receive the distributions.

The benefit of doing this is that your offspring will be able to access their benefits when they reach the legal age, which applies to the UTMA and UGMA accounts. They can’t access the funds until then. You’re also entitled to act as a trustee under this method.

The only downside is that it requires the help of an attorney and legal fees to set it up. But if you want a better understanding of the topic, Amazon has a great read on the subject!

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The Bottom Line

There’s been a lot of information to take in throughout this article, and we understand that you have your own set of individual goals. After all, no two situations are ever the same. The financial plan you require will be vastly different from anyone else’s.

So let’s leave you with this… Remember that the more you earn, the more complex your finances will be. Can you confidently say, without a clue of doubt, that all your finances are set up and working for you and your goals?

Lots of family fortunes rarely make it to a third generation. This means your wealth most likely won’t hold up for your grandchildren if you don’t plan ahead. Andrew Carnegie once said, “Shirtsleeves to shirtsleeves in three generations.”

As the first generation, you have worked hard for your money and taken the required steps to maintain it, hopefully in a portfolio of diversified funds with the confidence that you’ll have enough to live out your ideal retirement.

You should want to take what’s left of your wealth and pass it on to your children….And, hopefully, your children’s children!

If financial planning is up your alley, we have many more great subjects for you. We recommend you also read: Here Are 10 Tax Credits You May Qualify For


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