Parents, guardians, and grandparents always seek to do what is best for their children and grandchildren. Every parent wishes that their kids enjoy the wealth they have worked for during their lifetime. Apart from wealth, kids should also enjoy values, connections, and family traditions. It is essential to lay the proper foundation and pass the correct financial legacy to your kids without any interference. If we don’t manage our wealth thoughtfully, we risk leaving the future generation with unforeseen complications. Tax-efficient ways are the most convenient means of transferring wealth from one generation to another. Here are five tax-efficient ways to share wealth with kids.
5. Child IRAs
A child IRA is similar to an adult IRA when we consider the IRS. Child IRAs are accounts where you can only make transfers from your earned income. You are not allowed to transfer gifts or any other monetary value. When your child is of legal age and is working and earning an income to which they don’t need direct access, they can still use an IRA, which has crucial long-term value. A child IRA is similar to an adult IRA in that you can create it either as a Roth IRA or a traditional IRA. Traditional IRA operates by allowing deductions for income taxes when you make contributions. You are the only one who is taxed, and your child will be taxed when they make withdrawals in the future, hopefully when you have already retired. On the other hand, in a Roth IRA, there are no immediate tax deductions on you as an income earner or on any assets that you earn. Also, when your child makes future withdrawals, they are not taxed unless they are at least fifty-nine years old and have a Roth account for five consecutive years. There are also contribution needs that need to be considered. A Roth IRA is the most efficient account to set up if you are a high-income earner and expect your tax range to fall on a higher tax bracket.
4. Grantor Retained Annuity Trusts
Trusts are the most beneficial ways to contribute gifts to minors. According to Aspirant, Grantor Retained Annuity Trusts allow you to transfer assets to your child in a tax-efficient way. There is no specific way of creating trust, but there are tax rules which you will need to follow. Trusts involve the law with complicated tax procedures which are hard to understand, making it necessary to involve an attorney or an estate agent. The definition of a Grantor Retained Annuity Trust is a confidential agreement that names a grantor to manage annuity payments on behalf of the beneficiary until they are of legal age. The main disadvantage of this method is that the grantor needs to see the GRAT term to the end.
3. Crummey Trusts
It is the second type of trust named after Clifford Crummey, who was the first to use this method successfully. The Crummey trust enables parents to make contributions on behalf of their children. According to Financialpost, parents are also allowed to make annual gift exclusions, and they can decide when and how their kids are to access the funds. This type of trust protects your assets by allowing the grantor to formulate conditional terms or requirements for your child to receive the distributions. The benefit of this trust is that your child can access their benefits when they reach a legal age which applies to the UTMA and UGMA accounts. Your child cannot access funds until then. You are also allowed to act as a trustee under this method. The downside is that it requires the help of an attorney and legal fees to set it up. Other complicated legal procedures need to be followed.
2. Five-Two-Nine Plans
Five twenty-nine plans is one of the most tax-efficient ways of sharing the wealth with kids that is becoming extremely popular. The plan involves setting up a 529 account used as a gifts fund for education expenses. The primary benefit of the account is that any income transfer made into the account is free from federal income tax as long as they are classified under qualified expenses like educational expenses. The gains from the account are not taxable under the state and local laws, but this is subject to confirmation with your primary advisor. The account is similar to a custodial account in that it allows the parent, guardian, or grandparent to appoint someone who will manage the funds, which prevents kids from having direct control of the funds. According to Kiplinger, the only difference is that in 529 plans, beneficiaries do not have the full legal right to receive the transfer funds.
1. UTMA/UGMA Accounts
Uniform Transfer to Minors Act (UTMA) or Uniform Gift to Minors Act (UGMA) is a simple method of transferring wealth to kids by setting a custodial account under one of these accounts. These accounts are opened to enable those in charge to set aside gifts for children who are not of legal age to own a significant amount of property. According to Aesinternational, custodial accounts enable you to appoint someone or yourself to be in charge of your child’s gifts fund until they are of legal age, 18 or 21, depending on your country. The advantage of this method is that it takes zero effort to open these accounts. The accounts are set up with regular provisions which follow the law, and they are easy to open because you request your bank to create a custodial account on your behalf. You should be aware that custodial accounts are taxable on the child; it is advisable to open custodial accounts if you have a relatively small amount of gifts.