HFHHHFR
HFHHHHHF
I received an interesting call yesterday. The call was from a couple I’ll call the Smiths, who wanted to gift money to their grandchildren, and wanted information on how to complete this process.
In recent podcasts, I spoke about spending money accumulated over a lifetime. For more information, you can see my blogs titled: MY ROTH IRA (UN)SPENDING, and FINDING THE SPENDING “YES” THAT’S BIGGER THAN THE “NO”. This couple has a different problem. They have excess money and are not afraid to spend it. Their problem concerns the most effective way to give gifts to their grandchildren while not significantly altering their financial growth journey.
They fear significant amounts of unearned money will adversely affect the early financial struggles of their grandchildren. These are the same struggles most people encounter when growing up and starting to live independently.
Much as the caterpillars must struggle to become beautiful butterflies, this couple feels these early financial struggles will shape stronger and more beautiful adult grandchildren.
I’ve known the Smiths for many years. Mr. Smith worked for a major corporation with great benefits. Early in his career he recognized the power of investing in his company’s retirement plan and had maximized his contributions. As was common with many couples during his career, the man was the primary breadwinner. The couple lived conservatively and saved wisely.
Mr. and Mrs. Smith’s conservative lifestyle and aggressive investing allowed Mr. Smith to retire at a relatively young age.
Mr. and Mrs. Smith traveled domestically and internationally. Their home is mortgage-free, they own both their vehicles, and they have no other debt. Even with spending for vehicles, travel, and a new home they built several years ago, their retirement accounts continue to appreciate.
hfhhfhfhf
So, What’s Their Problem?
To be direct, their problem is that they have too much money! Mr. and Mrs. Smith have lived conservatively and continue to do so. Now in their late 70s, they related that they have lost their passion for travel. They have no mortgages and spend freely on things they desire. They desire very little, as they feel they have everything they need. The value of their retirement accounts continues to grow. They now find themselves unable to spend all the dollars their retirement accounts generate.
Their problem………. They are drowning in a sea of cash!
Because of this growing “problem”, Mr. and Mrs. Smith decided they want to provide financial gifts to their grandchildren who range in age from late teens to late 20s. Mr. Smith’s questions focused on how to give these gifts in the best manner
hfhfhgfg
529 Plans
The first and most obvious answer to this question would be gifting through a state-sponsored 529 Plan.
What is a 529 Plan? A 529 plan is a tax-advantaged savings plan designed to encourage saving for future education expenses, such as college or K-12 tuition. These plans are offered by states, state agencies, or educational institutions and are authorized by Section 529 of the Internal Revenue Code. Key benefits include tax-deferred growth and tax-free withdrawals for qualified education expenses.
Here’s a more detailed breakdown:
Key Features:
- Tax Advantages: Earnings in a 529 plan grow tax-deferred, and withdrawals for qualified education expenses are federal and state tax-free.
- Qualified Expenses: These include tuition, fees, books, supplies, room and board (for students attending at least half-time), and even student loan repayments (up to a limit).
- Flexibility: 529 plans can be used for various educational institutions, including colleges, universities, vocational schools, and even K-12 tuition in some cases.
- Beneficiary: The beneficiary of a 529 plan can change to another family member if the original beneficiary’s plans change.
- Contribution Limits: While there are generally no income restrictions for opening a 529 plan, there are limits on how much can be contributed annually, which vary by state.
- Types of Plans: There are two main types: prepaid tuition plans and savings plans; savings plans are more common.
hfhhghghg
Direct Gifting
Due to the age of Mr. and Mrs. Smith’s grandchildren, they felt this form of gifting wouldn’t be a good fit. We moved on to the second most common form of gifting, which is Direct Gifting. Cash is an easy and quick way to benefit children and grandchildren. The United States government provides an easy way to gift cash to children and grandchildren. Cash can be given directly to the recipient within certain gifting limits. For 2025, this amount is $19,000 per person per year. Mr. and Mrs. Smith can each gift $19,000, effectively doubling the amount they can give tax-free to $38,000 in 2025.
Mr. and Mrs. Smith’s concern with this approach was giving a substantial amount of money to someone who may not fully appreciate the magnitude of the gift, or use that money wisely. Mr. Smith’s statement about this type of gifting was very wise.
He said he didn’t want his and Mrs. Smith’s financial gifts to interfere with his grandchildren’s ability to learn crucial life lessons. He feared their cash gifts to their grandchildren would increase inappropriate spending instead of building wise saving habits. He felt that placing a substantial amount of money in the hands of his young grandchildren would not produce the results they wanted to provide with gifting.
hghhghhg
Trusts
Now I’ve struck out twice, and I am trying to get on base! So we moved on to the subject of Trusts.
A trust is a legal arrangement where a person known as the grantor, settlor, or trustor, transfers assets to a trustee who holds and manages these assets for the benefit of designated beneficiaries.
A Grantor (the person who creates the trust) transfers assets into the trust to benefit a Beneficiary (person or organization who will benefit from the assets, receiving income or distributions.) These assets will be managed by a Trustee (The individual or entity responsible for managing the trust assets according to the grantor’s instructions.)
The grantor transfers assets to the trustee, who then manages and distributes them according to the trust document. Trustees have a fiduciary duty to act in the best interests of the beneficiaries.
Types of Trusts:
- Living Trusts (Inter Vivos Trusts): Created during the grantor’s lifetime and can be either revocable or irrevocable.
- Testamentary Trusts: Created through a will and take effect upon the grantor’s death.
- Revocable Trusts: Can be changed or revoked by the grantor during their lifetime.
- Irrevocable Trusts: Cannot be altered or revoked by the grantor after creation, offering potential tax benefits and asset protection.
- Benefits of using a trust:
- Avoiding probate: Trusts can help bypass the often lengthy and public probate process.
- Asset protection: Certain trusts, like irrevocable trusts, can shield assets from creditors and lawsuits.
- Tax benefits: Irrevocable trusts can minimize estate taxes by removing assets from the grantor’s taxable estate.
- Control over asset distribution: Trusts allow the grantor to specify how and when assets are distributed to beneficiaries.
- Privacy: Trusts are generally private, unlike wills which become public record during probate.
- Planning for incapacity: A trust can designate a successor trustee to manage assets if the grantor becomes incapacitated.
- How trusts differ from wills:
- Timing: Trusts can take effect immediately, while wills are effective only upon death.
- Probate: Trusts can help avoid probate, while wills require it.
- Control: Trusts allow the grantor to retain control during their lifetime and plan for incapacity, while wills do not.
- Privacy: Trusts offer privacy, while wills are public record during probate.
Important Notes:
- Setting up a trust involves legal complexities and it’s generally advisable to consult with an estate planning attorney.
- The type of trust you choose depends on individual circumstances, financial goals, and family dynamics.
- Trusts are used for a variety of purposes. Providing for family members, minimizing taxes, protecting assets, and supporting charitable causes are various trust objectives
- The cost of establishing and maintaining one should be considered before establishing a trust.
- Tax considerations: It’s crucial to consult with a tax professional to understand the specific tax implications of your trust and how it aligns with your financial and wealth-transfer goals. Taxation of trusts differs according to the type of Trust.
Revocable Trusts (Grantor Trusts):
- Tax Treatment: Revocable trusts, or living trusts, are disregarded for tax purposes during the grantor’s lifetime.
- Income Reporting: Any income generated by assets in a revocable trust is reported on the grantor’s income tax return, and the trust itself does not file a separate tax return.
- Grantor’s Control: The grantor retains control over the trust and its assets, meaning they are treated as the owner for income tax purposes.
Irrevocable Trusts (Non-Grantor Trusts):
- Tax Treatment: Irrevocable trusts are considered separate legal entities for tax purposes.
- Income Reporting: The trust must file its tax return (Form 1041) and pay taxes on any income not distributed to beneficiaries.
- Trust Tax Rates: Trusts are subject to their income tax brackets, which are more compressed than individual tax brackets. Example (2025): A trust reaches the highest federal income tax rate of 37% on income over $15,650. This contrasts significantly with the income threshold for individuals reaching the top tax bracket.
- Distributions to Beneficiaries: If income is distributed to beneficiaries, it is generally taxed to the beneficiaries, who may be in lower tax brackets. This can incentivize trustees to distribute income to beneficiaries to reduce the overall tax burden.
- Capital Gains: Capital gains within the trust are taxed at the trust level.
- Net Investment Income Tax (NIIT): Trusts may also be subject to the 3.8% NIIT on undistributed investment income.
In summary:
- Revocable trusts: Income is taxed to the grantor.
- Irrevocable trusts: Income is generally taxed to the trust, unless distributed to beneficiaries. Distributed income is taxed to the beneficiaries.
Important Notes:
- State Taxes: Several states also tax fiduciary income, which can influence the type of trust and jurisdiction for tax purposes.
- Form 1041: Estates and trusts that generate over $600 in annual gross income are generally required to file Form 1041.
- Tax Cuts and Jobs Act (TCJA): Trusts and estates benefit from reduced tax rates under the TCJA. These rates are set to expire after 2025 unless future legislation is passed.
hfhfhhhfh
Mr. Smith liked the idea of creating a Trust now that he and Mrs. Smith have the ability to generously fund a Trust. Mr. Smith was NOT in love with the legal complexity, nor did he like the harsher tax treatment of income generated by trusts.
fhfhhfhf
Using Gifts to Fund Retirement Accounts
We moved on to my fourth gifting suggestion. By now it was apparent that Mr. and Mrs. Smith wanted to be generous with their grandchildren, but without providing direct cash payments that could be misspent by their grandchildren. Using this information, my next suggestion was that they fully fund Roth IRA or Roth 401(k) accounts for their grandchildren when they start working. Even though Roth accounts are taxed at the time of the contribution, Mr. and Mrs. Smith’s grandchildren are at a point in their careers where their income will be lowest, and Roth contributions will generate little or no increase in tax liability.
They liked this idea, as they would be providing gifts for their grandchildren, grandchildren would have limited access to the money, and they would be helping to establish a great financial base for their grandchildren‘s future. They also appreciated the relative ease of gifting compared to other more complex gifting ideas I provided.
Gifting by contributing to individual Roth IRA accounts for each grandchild satisfies almost all of the concerns that Mr. and Mrs. Smith related.
No form of gifting is without negatives. Mr. and Mrs. Smith’s grandchildren must have earned income and contributions can’t exceed earned income. Another drawback is that gifts are limited to annual Roth contribution limits. Earnings within Roth IRA accounts are subject to penalties and taxes if the account holder is less than 59 1/2 years old and the account is less than five years old. Contributions to Roth IRAs (because contributions have been previously taxed) can be distributed at any point without taxes or penalties. This can be a problem because the account holder can withdraw contributions without taxation or penalty.
Mr. and Mrs. Smith liked this last idea, and will most likely implement gifting to fund Roth accounts for their grandchildren at the beginning of their careers.
As their grandchildren mature and become more financially capable, they will most likely proceed to direct gifting.
Eventually, they may move to a Trust arrangement to provide gifts to their grandchildren, while directing how those gifts will be provided.
fhjfhfhf
fhjffjhfj
Final Thoughts
If this article were a baseball game, my batting average would be two hundred and fifty (.250), as only one of the four main gifting idea ideas provided was acceptable to them.
This is not a baseball game, and I feel I batted one thousand (1.000), as I provided useful information about four major gifting modes for their grandchildren.
I spoke tongue-in-cheek about their “problem” of excess money. They are great parents and grandparents and want to share their wealth in the best way possible. This means providing gifts that will aid their grandchildren, while not impeding their grandchildren’s financial growth.
I decided to turn their question into a blog and podcast, because the questions they have are questions that many retirees face.
Not every retiree has the luxury of excess dollars, and some are reluctant to let go of those dollars. They are unwilling to gift with “warm hands” and would rather pass those dollars onto their heirs after they are gone and no longer need their money.
If you have questions and would like answers, email me through my blog site, or direct message me through the podcast hosting site.
hfhhhf
fhfhhfhhf
If you’d like to be a part of a free online retirement community, join us on Facebook:
COMMENTS