It’s not uncommon to want to leave a gift for your children and family members at your death. We find that clients who are in a position to share their wealth with others often plan to do so through their Last Will & Testament.
However, the reality of the situation is, many of our children have financial needs now. Would it be more helpful to your children, or more enjoyable for you, if you were able to give during your lifetime? Are there options to share your gift in a way that is both generous and financially wise?
Put Your Retirement First
The desire to help others is a good thing, but you’ll need the financial resources to do so. That’s why it’s so important to make sure your financial plan will provide for your own needs, including the possibility of long-term care. Once you’re comfortable and feel you can afford to give money to your family members without jeopardizing your own retirement, it’s time to think about ways you can make the most of your gifts.
Before making a gift, think carefully about the rewards and risks of doing so. Could this impact your tax liability? Will some family members question the “fairness” of your giving? If you have a specific goal in mind, will your gift be used as you intend?
Ask yourself these questions
Are all your children (or grandchildren) being treated equally?
You may have very good reasons for not leaving each of your children an equal inheritance. Often, one child has greater financial needs than another, or you may feel closer to some family members than others.
Whatever your reasoning is for dividing your estate unequally, it’s your decision. If you are giving more to one child, consider whether this will create resentment. It can be helpful to talk about your estate planning and your giving philosophy with your children now, but if you are not comfortable doing that, you may want to leave a letter that explains your decisions.
Is this really a gift...?
When gifting money to family members, do you expect the it to be used for a specific purpose? Do you expect anything in return? Is the gift an advance on a future inheritance? For whatever stipulation you have around your gift,it’s best to put it in writing now to avoid future misunderstandings.
...Or should you make it a loan?
Loaning money to family members could be an alternative to gifting them money. In today’s low interest rate environment, making a loan could be a win-win for you and your family member. Perhaps you have substantial liquidity and can part ways with the funds while simultaneously charging a reasonable interest rate (which could be a slightly higher interest rate than what you would get in a High Yield Savings Account).. If your family member can only obtain financing in the open market at higher rates than what you are willing to offer,, taking the loan from you could be in their best interests. There are tax complexities associated with this strategy so we encourage you to work with your financial planning and tax professional in order to ensure the loan interest rate meets applicable IRS guidelines.
Does your child need help with medical, dental, or educational expenses?
Consider paying for these expenses directly. This can be a great way to lift a financial stressor off your child. There is no limit or reporting requirement for payments made directly to medical and/or educational institutions for health care expenses and tuition for others.
Is your child in a lower tax bracket than you are?
If your child or the person to whom you are considering making a gift is in a lower tax bracket than you are, consider gifting securities (stocks, mutual funds, ETF’s) as opposed to cash. This is particularly true if you happen to hold securities that have appreciated in value and would result in a capital gain if you were to sell them.
For taxpayers who are in the 22 percent marginal Federal income tax bracket (or higher), they will owe Federal capital gains tax of at least 15 percent when these appreciated securities are sold.
When considering gifting to individuals who may be in the 10 or 12 percent marginal Federal income tax bracket, consider gifting appreciated securities, which the person receiving the gift could then turn around and sell. If the person receiving the gift is in one of these lower tax brackets, they could sell the securities and the Federal capital gains rate could be 0 percent (depending on their overall income).
Do you want to help with college costs for your grandchildren?
One of the best ways to save for a child’s future education is by funding a 529 plan. You can create an account on your own for your grandchild or contribute to an account created by the child’s parent. These accounts will grow tax deferred, and the income and growth is never taxed as long as the funds are used for higher education expenses.
If you are giving money, are you taking advantage of tax-free gifting?
Today in 2022, you can give up to $16,000 to a person in a year without reporting it to the IRS. If you are married, you and your spouse can each make an annual tax-free gift of up to $16,000; so together, a couple can give up to $32,000 per recipient each year with no reporting requirement. If you give more than that amount, you will need to file a gift tax return. While you won’t have to pay any taxes on the gift now, a portion of your lifetime gift exemption amount will be used.
If you have reached age 59.5 and are withdrawing the money you wish to gift from an Individual Retirement Account (IRA), you may incur additional taxes. A large withdrawal could push you into a higher tax bracket, increase the taxes on your Social Security payments and raise your Medicare premiums. If you give money from a traditional IRA distribution to your child (or anyone else), you’ll have to pay income taxes on what you pulled out, just as you would if you kept the money.
The IRS does not assess a gift tax until you have reached a certain threshold, called a lifetime exclusion. Over your lifetime, you can give up to $6.03 million in gifts without having to pay taxes on this money. If you're married, this amount doubles to $12.06 million because each spouse can give $6.03 million. As the tax code is written today (2022), the lifetime exemption will be roughly cut in half in 2025.
It helps to be working with a Certified Financial Planner™ professional to know whether or not your gifting decisions are aligned with your overall financial plan. There is never a one-size fits all approach to doing the right thing and careful analysis should be given to the variety of gifting methods available.
At Birchwood Financial Partners, we work with our clients to help them feel empowered and knowledgeable about the financial decisions they are making each and every day. We invite you to learn more about our firm, our team, our processes, our services, and the clients we currently serve.