Gifting to Children

Note: The advice in this article pertains to American readers only.

Gifting to our children can come in many forms. It can be for college planning needs, to assist in first-time home ownership, to provide a safety net for them, or to lower our estates. Whatever the need, the concepts are basically the same.

The easy and inexpensive transfers involve the UGMA (Uniform Gifts to Minors Act), which are accounts to hold financial assets, basically securities and cash. The UTMA (Uniform Transfer to Minors Act) are accounts that can hold financial assets, real estate, and collectibles. Both let you transfer assets to a custodian (caretaker) of the account for the benefit of a minor. The gifts are tax-free if the total value per year is $12,000 (indexed each year) or less. These accounts cost nothing to set up and involve minimal paperwork.

They work in the following way:

• You can keep the child from using the assets until they reach legal age, but you cannot take the assets back.

• The custodian can spend or invest in any way that helps the child.

• There can be only one custodian and one beneficiary per account.

• Income from the gift is taxed to the child, not to you, and will be taxed at the current applicable "Kiddie Tax" rates.

- "Kiddie Tax" in 2006: any child under the age of 18, with more that $750 of unearned income (income that comes from investments) or a total earned income of more than $5,150 must file a tax return. After the first tax-free $850, the next $850 of unearned income is taxed at the child's rate of 10% and the amounts over $1,700 are taxed at the parents' tax rate. The concept of this is to prevent parents from transferring too many assets to children simply to avoid paying income tax.

• The assets will still be considered part of your estate when you die, unless you have named someone else to act as the custodian.

Words of Caution to Parents

A couple of things to watch out for with UTMA and UGMA accounts:

• Once a child reaches legal age (18 or 21 depending on your state), s/he is entitled to spend the money or sell the asset without your permission. You will no longer have control.

• If you request financial aid, the school will consider the child's assets when making its decision. Since students are expected to contribute more of their savings to their own education than their parents, the extra money held for a child in an UGMA or UTMA could result in less assistance.

Education Plans

College plans specifically have assets that will provide either an educational benefit, or will assist in primary or secondary education, and are earmarked for that purpose only. These plans are 529 plans, prepaid tuition plans, or educational IRAs.

They work as follows:

• In an educational IRA, the assets belong to the child, but you can control the investment options. The yearly amount that can be contributed to these accounts is $2,000, and there are phase-outs based on your income levels.

• 529 plan assets can have any beneficiary and are totally controlled by the account owner. All gains in the account are income tax free if used for continuing education. The true benefits of these accounts are the tax deferred and tax redeemed growth, the beneficiary control, and the fact that the owner can invest the account any way they see fit.

Other Options

For more control, you can elect an irrevocable trust, and name someone else as the trustee to manage and distribute the money according to your wishes until the child reaches an age that you select. Until then, the child will not have any control over the money; although, the trustee can use it for the child's health needs, education, or maintaining a modest lifestyle. These assets are totally out of your estate if you elect an irrevocable trust. Remember, if you retain control in any way with any gifted assets, then the assets will be included in your estate for estate tax purposes.

For special needs situations, one can create a "Special Needs Trust." These trusts allow someone to gift assets into a trust that will be used only for special needs situations. They can be used if you have a disabled child or if you want to provide for the child's basic living expenses. This trust will prevent a reduction in the SSI (social security income) to your child if s/he is eligible for assistance.

All in all, there are many ways to handle gifting to children. Key points to remember are that the annual gift tax exclusion amount is $12,000 (2006). The unified gift tax credit is $1,000,000. It is wise to do a gift tax return in the year that you gift assets, so that there is a record of the gift. Often this is overlooked. Also use caution and set up a trust with an attorney who specializes in estate planning. To help you achieve your most optimal situation, ask your financial advisor to act as your coordinator between an estate attorney and accountant.

Cindy Diccianni is a Registered Nurse, a Certified Senior Advisor (CSA), a Certified Long Term Consultant (CLTC), a Registered Investment Advisor and a Registered Representative with Leigh Baldwin & Company member NASD and SIPC. She is affiliated with Ortner, O'Brien & Ortner Advisory Group, Inc., Malvern PA. Her passion is assisting clients in creating financial freedom. You may contact her at Cindy@taxlegalfinancial.com.

Words of Caution to Parents

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About the Author

Cindy Diccianni, RN, CSA, CWI, CLTC

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