A Christmas Gift that Potentially Keeps on Giving

 

Christmas is a wonderful time of year that brings an abundance of joy through Faith, family, fellowship, and gift-giving. Many of our clients have children and grandchildren they would like to get Christmas gifts for.  Rather than material items such as toys or video games their children or grandchildren would be happier to receive cash or a gift card to their favorite store so they can buy what they really want. However, what if you could put that cash or gift card money to work for them so that it could provide opportunities for them in the future?

There are several ways for a parent or grandparent to invest money for their kids or grandkids. My goal is to highlight a few of the many possibilities.  Depending on your goals and financial situation some of the options discussed in this article may be a fit while others may not.  Additionally, there may be other options for investing in the next generation that is not covered in this article.

A 529 College Savings Plan, while not as instantly gratifying as an Xbox or basketball goal, is a great gift for your children or grandchildren that could be very beneficial for their future.  With a 529 Plan, you can contribute money for the benefit of someone you care about and have the money grow tax-deferred.  If the money is used for qualified educational expenses (books, tuition, room & board, etc.) then the contribution and growth can be withdrawn tax free. For example, if you have a 5-year-old grandchild, and you open a 529 account for them with $250 (for purposes of this article let’s assume you never add to it) and by the time they are ready to use the funds for education it is worth $1,000, every dollar can go towards their school expenses without being taxed. Each state has a sponsor for their 529 plans; and some states may have additional tax benefits.  Also, investment minimums may differ depending on the plan’s rules.

Common questions I get asked regarding 529s are:  If I open the 529 in South Carolina because that is where I live, does my child have to use the money at a South Carolina college or university? And What if my child or grandchild does not go to college or doesn’t use all the funds in the 529?  No matter where you live, the 529 funds can be used at any qualified institution from South Carolina to Hawaii. Also, you can always change the beneficiary to another child or grandchild in order to give another person the opportunity to use the money. However, if at some point you have no one listed as a beneficiary, withdrawing the money will incur a 10% penalty plus taxes on the growth. This can be a drawback to the 529 but historically, the long-term growth can help make up for the 10% penalty.

A Uniform Transfer to Minors Act or Uniform Gift to Minors Act account is another way to give a meaningful gift this Christmas. UTMAs or UGMAs are taxable accounts funded with after-tax dollars and while they are not tax-sheltered, earnings up to a certain amount may be tax free. Parents can gift up to $15,000 per year ($30,000 for a married couple) without having to be concerned with gift taxes these limits will increase to $16,000/$32,000 in 2022. UTMAs or UGMAs can be used to fund education or any expenses for the benefit of the child. UGMAs can only be funded with cash or securities (stocks, bonds, mutual funds, etc.) while UTMAs can contain real estate, securities, or other intellectual property. These two account types tend to be used interchangeably but it depends on which designation your state has adopted to indicate which account is available to you. With these types of accounts, the assets are controlled by the custodian, usually, a parent or guardian, until the beneficiary reaches the age of adulthood, which can vary by state, in South Carolina it is 18. At that time, the beneficiary can do what they want with the account. If they want to invest it on their own, they can. If they want to take the money and buy a motorcycle, they can. Therefore, you may want to take into consideration whether the child will be a good steward of money in the future.

A Roth IRA is also an option to consider when it comes to the gift of a financial future for kids and grandkids. A Roth IRA is contributed to with after-tax dollars and the earnings grow tax-free provided that certain rules are followed. Because contributions are after-tax, one can withdraw contributions at any time, for any reason with no taxes or early withdrawal penalties. However, there are contribution limits; $6,000 per year if you are under 50 and $7,000 per year if you are over 50.  There are also income limits to opening and/or funding a Roth IRA. The minimum to open a Roth IRA can vary depending on where you invest the money but generally $250 as an initial deposit or $50 per month bank draft can be expected. In order to take the earnings out tax-free, the Roth owner must be 59.5 and have had a Roth IRA for at least 5 years. Another stipulation to a Roth IRA is that the owner must have earned income.

So, why should you consider a Roth IRA for your child or grandchild? While this may not be viable for an infant or toddler, if your young loved one is old enough to complete household chores, help clean and take the trash out at your work, or help Grandma with her garden then you can pay them for doing such things and fund a Roth IRA that way. Obviously, it is a stretch for a young child to fully fund a Roth IRA by doing chores or cleaning a bathroom, but could they make $250 to $500 over the course of a year for doing these things? Sure, and remember the potential growth could be 100% tax-free.  When I was little, my dad would pay me a few dollars an hour to take the trash out at his office. Also, every summer starting from when I was around 9 years old, I would go door to door in my neighborhood selling produce from the farmers market, and anything I made over what we paid for the produce I would get to keep for my work. That’s how my Roth IRA was started. Like UGMAs and UTMAs, the account is controlled by the parent as the custodian until the child reaches adulthood.

The above examples are to give a few basic ideas of ways to give a financial gift to future generations of loved ones.  Remember there are rules, stipulations, and circumstances that are beyond the scope of this article. Always speak to a financial professional and/or tax advisor before making any investment decisions. However, why not consider a Christmas gift this season that can be meaningful not only this Christmas but for years to come?

Craig McDaniel Jr.

Financial Advisor

Certain information herein has been obtained from third-party sources believed to be reliable, but we do not guarantee or warrant its completeness or accuracy. This commentary is a general communication and is provided for informational and/or educational purposes only. None of the content should be viewed as a suggestion that you take or refrain from taking any action nor as a recommendation for any specific investment product, strategy, or other such purpose.

 

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