The Right Way to Gift Money to Your Kids
If you want your children to learn the right way to handle money, they need to have some money to handle. Many gifts have limited usefulness; toys break, sweaters pill and gadgets are quickly replaced by newer models. The gift of money gives your children the benefit of making choices.
You must gift money thoughtfully, keeping in mind everything from etiquette to tax implications. Whether you are gifting money to children for the holidays, birthdays, or graduation, there are some steps you can take to help them understand your intent, their options, and the value of the gift.
What Do You Want to Accomplish?
Before giving a monetary gift, understand why you’re doing it. You might be looking to fund a future goal like college or retirement or to teach a child how to invest in stocks or mutual funds. You might want to see the joy on your child's face when they realize they have cash of their own to spend. Perhaps you simply have no idea what to buy the child.
Each of these reasons should be handled in different ways. Make sure the child you're giving to knows what strings are attached; or if there are none, communicate that as well.
What Gifting Money Means to a Child
You might inadvertently disappoint a seven-year-old grandchild at Christmas by putting a check in their stocking. Younger children generally don't understand the concept behind a check, and won't give much of a reaction when receiving it.
Cash works better, but even that needs to be in a form that the recipient can understand. All bills appear to be the same to younger children, and you might need to communicate that they may not get to hold on to it—even those kids who do understand the differences should know that they won't get to hang onto a hundred dollar bill. It’s simply too much money to entrust to younger kids.
If you want to give a gift of cash, break it down into pieces a child can easily understand to help them learn to handle money. For young children, consider a roll of quarters provided that they are not so young that quarters present a choking hazard. For pre-adolescents and teens, you could give bills with a letter that explains the gift.
Try offering an explanation of the gift and why you are giving it. Then, suggest a few ways to use it.
One method of communicating the use of gift money to your children is to explain why they are receiving it, then giving them a few suggestions to get the thought process flowing. In this way, you haven't attached any strings to the money, but you have offered some suggestions and guidance on its use.
Set Gifting Expectations Carefully
It helps that you be clear and careful about your intentions when you begin a pattern of gifting, especially when giving large sums to older or adult children.
Recipients can very quickly come to both expect and, in some cases, depend on these gifts. They might start budgeting for them for college expenses, home renovations, annual vacations, or others. If you have an intention to gift once or only do it sporadically, let your children know this so they can have appropriate expectations.
Tax Implications for Larger Gifts
The Internal Revenue Service (IRS) has very straightforward rules on gifting money. In 2020, you can give up to $15,000 to an individual each year; your spouse can do the same, which allows for a joint gift of $30,000 annually. If you want to give more than that, you can dip into the $11 million-plus you’re allowed to give away during your lifetime or at death.
This limit has increased for the periods through 2025, due to the Tax Cuts and Jobs Act, meaning married couples can exempt a total of $22 million in lifetime gifts. This will, however, trigger the need to file a gift-tax return. These taxes came about because the wealthy use gifting to move money out of their estate prior to death so that it won’t be subject to estate taxes.
Gifting larger amounts of money to your children can have extra tax implications. A child's unearned income is limited to $2,200 before being taxed.
You’ll also need to know and understand the kiddie tax, especially if you want to use the gift as an investment lesson. This IRS provision was established to prevent well-to-do parents in high tax brackets from trying to shelter money in the names and custodial accounts of their children who happen to be in lower tax brackets.
If a child's unearned income totals more than $2,200, part of that income may be subject to tax at the parent's tax rate instead of the child's tax rate. See the Form 8615 Instructions, "Tax for Certain Children Who Have Unearned Income."
Gift Today for Tomorrow
A gift of money has particular value when it goes towards funding future dreams such as college or retirement—it has to be invested wisely, however.
If your child works, you can contribute to a Roth Individual Retirement Account (IRA) on his or her behalf in an amount equal to their income, up to the yearly cap of $5,500. The gifts count as part of the $15,000 you’re allowed to give them annually.
When you make the gift of a Roth IRA contribution, you should sit down with your child and talk about how to invest the money to make it grow for the future, or gift it alongside a personal finance book. You could also put the funds in an account at an online robo-brokerage website like Wealthfront or Betterment, then give your kids the password so they can log in and follow the progress.
If you intend the gift for college expenses, there’s a tax provision often used by generous grandparents that allows five years of $15,000 gifts to be made at once to a 529 college savings account. That gives the money more time to compound, earning more in interest for the recipient.
The Gifting Baggage
Finally, there’s absolutely no doubt that the gift of money comes with baggage. There can be expectations of more, taxes or hard feelings from those that receive less or not at all—with all the emotions and greed surrounding money, something to remember is that regardless of what follows the gifting, it feels good to give money to help a child in your life.
Internal Revenue Service. "Frequently Asked Questions on Gift Taxes." Accessed Mar. 21, 2020.