wealth transfer

How to Give Financial Gifts to Loved Ones

Make sure your clients plan properly and take taxes and legal considerations into account

Reprinted with permission from Fidelity Viewpoints. Visit here.

November 1, 2016 — Giving to a loved one or charity can be one of life’s greatest joys. But when it comes to gifting, there are some key issues, including potential tax implications, that you’ll want to keep in mind in order to make the most of your gift.

The most important thing to remember is that financial gifts are irrevocable: Once you make the gift and record it on your federal tax documents, you can’t take it back.

“Every client, no matter how much wealth he or she has, needs to understand that a gift is irrevocable,” says Pamela Pirone-Benson, estate planning specialist with Fidelity. “Ask yourself, ‘How does it fit into my overall financial picture and financial health? Does it make sense to give up this money? Could it cause financial struggles or issues in the future?’ ”

Why give money?

Take time to consider why you are gifting. The pros include a feeling of generosity and the ability to make things easier for future generations. “I call it the ‘feel good’ factor, or the grandparent effect,” says Pirone-Benson. “You’ve worked hard and saved and now you want to give something to your children and grandchildren to help them.”

Sander Bleustein, estate planning specialist at Fidelity, adds, “One thing I hear a lot is, ‘I want to see them enjoy the money now.’” In other words, why wait until after you die to distribute the money to loved ones?

Another advantage is that gifting can help reduce the size of your taxable estate and with it your eventual estate tax liabilities. On the other hand, gifting can have potential tax implications and loss of control over gifted assets. So weigh the pros and cons before you make a commitment.

Know the basics

Each person is allowed to gift $14,000 each year to any individual. Any amount beyond that will involve using part of your lifetime federal gift tax exclusion, which is currently $5.45 million. A married couple could therefore give $28,000 to each of their children and grandchildren and anyone else each year without beginning to use that exclusion, which would be a combined $10.9 million.

If you do exceed the annual exclusion amount, you’ll need to file a gift tax return and track the amounts given each year. Bleustein notes, “If you work with a CPA, let him or her know you’ve made these gifts.”

Consider capital gains taxes

Next, think of the income and capital gains tax consequences for the beneficiary of the gift. Not all gifts are treated equally. If you gift cash, generally there are no income tax consequences for the recipient, though there could be gift and estate tax implications to the donor. But if you give appreciated securities, the capital gains taxes can be significant. Also, note that the tax treatment varies widely depending on the person or entity receiving the gift.

Consider a hypothetical $14,000 gift of cash. You give it to a child or grandchild, and he or she keeps the entire $14,000. But a $14,000 gift of Apple stock, for example, held for 10 years and with a cost basis of $2,000 when sold would result in a 15% long-term capital gains tax for people in the 25%, 28%, 33%, or 35% ordinary income tax bracket.1 So, potentially, the gift beneficiary would owe 15% of $12,000, or $1,800 in federal capital gains tax plus any applicable state tax at the time of sale. For example, for New York state residents, it would mean another 6.65%, or close to $800 in tax. That’s $2,600 paid in taxes on the subsequent sale of the $14,000 gift of appreciated stock.

Taxable gifts are not limited to cash in an amount in excess of the annual exclusion or securities, however. “Sometimes a gift doesn’t present itself as a check to someone,” Pirone-Benson explains. “If you pay a premium for a life insurance policy, but your children own the policy, it might be considered a gift and may be taxable.”

The role of trusts

One thing I hear a lot is, ‘I want to see them enjoy the money now.’” In other words, why wait until after you die to distribute the money to loved ones?

Irrevocable trusts can be beneficial to a donor considering gifting to minor children, as trusts allow for more control of the assets, even after the donor’s death. By setting up a trust, you can communicate how you want the money you leave to your children to be managed, the circumstances under which it can be distributed, and when it should be withheld. You can also specify in the documentation whether your children will be able to control the money at a certain age as either co-trustees or as recipients of the full balance of the trust.

As a donor, you may or may not want to appoint a guardian of any minors as trustee. If not, the trust can also include provisions dictating what access, if any, the guardian should have to the assets.

An irrevocable trust can also be an effective tool for transferring assets to an adult child, while potentially reducing estate taxes and directing how you would like the assets to be handled after you have passed away. A single trust can cover all your children.

If you would like to make significant bequests to charity either during your lifetime or at your death, a charitable lead trust or a charitable remainder trust may make sense. A charitable lead trust allows certain benefits to go to a charity and the remainder to your beneficiaries. A charitable remainder trust allows you to receive an income stream for a defined period of time and stipulate that any remainder go to a charity.

Consider whether a custodial account or a trust is most appropriate for your situation. One drawback to a custodial account is that your child will typically inherit the money at the age of majority (the precise age depends on state law), which might not be ideal. You might not feel confident that your child will make the most responsible decisions with a large sum of money at that age.

There are many other advantages to using a trust. The money could be protected from lawsuits, creditor claims, and divorce settlements, so long as the trust is structured properly. “It can help ensure that the assets end up where you want them to go, with fewer unforeseen risks,” Pirone-Benson says. Make sure you consult an attorney before setting up a trust.

Focused on college? Think about a 529 plan account

If your focus is largely on helping a child, grandchild, or other young person pay for college, an Internal Revenue Code Section 529 qualified tuition program, also known as a “529 plan,” can be a powerful tool. A big plus with this type of account is that you and your spouse can front-load five years’ worth of your annual exclusion gifts. Together, you could give five times the combined total of $28,000 for this year, or $140,000, to each of your children or grandchildren without touching your lifetime federal gift tax exclusion for couples of $10.9 million.2

Charitably inclined? Consider a donor-advised fund

One of the most effective and easiest ways to give to charity is through a donor-advised fund. Instead of naming individual charities as beneficiaries in your individual retirement account, for example, which can create an administrative headache, you can simply name a donor-advised fund.

You can also front-load your charitable donations. By making a large donation to the account, you can claim a tax deduction in the year of the gift. However, the money needn’t be distributed to the actual charity in the year you make the contribution. You can let the money grow and you can decide later how the money will be distributed.

“This is a great strategy if you are in a high income-tax year. You might be transitioning into retirement and receive one-time deferred compensation payouts or severance payments,” Bleustein says. By making an up-front charitable contribution, you could potentially reduce some of those taxes, and you will be set up for future gifting.

Another advantage is that the account can continue to exist after you die. You can potentially pass on your philanthropic activity and have your children continue to carry out your wishes after you die, putting their own stamp on it, working together to give money to deserving charities.