The Right Way to Gift Money to Your Kids
If you want your kids to learn the right way to handle money, they have to have some money to handle. Many gifts have limited usefulness; toys break, sweaters pill and gadgets get quickly replaced by newer models, but the gift of money keeps on giving.
You must gift money thoughtfully, keeping in mind everything from etiquette to tax implications. Whether you’re giving money for the holidays, birthdays, or graduation, learn the smartest ways to give the green stuff.
What Do You Want to Accomplish?
Before giving a monetary gift, understand why you’re doing it. Are you looking to fund a future goal like college or retirement? Do you want to teach a child how to invest in stocks or mutual funds? Do you want to see the joy on your kid’s face when he realizes he has cash of his own to decide how to spend? Or did you just have no other ideas for what to buy your child?
Each of these reasons should be handled in different ways explains Susan Beacham, founder of Money Savvy Generation and co-author of OMG: The Official Money Guide for College Students. “If you want to give money as a gift, make sure it’s a gift and doesn’t have strings attached,” Beacham says. And if you do decide to attach some strings? "Make sure you are very upfront about that.”
What Cash Means to the Recipient
You might inadvertently disappoint a 7-year-old grandchild at Christmas by putting a check in her stocking. “If you’re expecting a super response from that child, you’re not going to get it,” says Beacham. Young children don't understand the abstract concept that a check means money that they can spend.
Cash works better, but even that needs to be in a form that the recipient can understand. “A hundred dollar bill is the same size as a twenty is the same size as a ten,” she says. “Some kids get it. Most kids don’t.” Even those kids who do understand also know that they won't get to just hang onto a hundred dollar bill because it’s too much money.
If you want to give a gift of cash, break it down into pieces a child can easily transact with to help them learn to handle money. For young children, consider a roll of quarters, provided that they’re not so young that quarters present a choking hazard. For pre-adolescents and teens, give bills with a letter that explains the gift.
Beachem suggests an explanation such as the following:
“What we’re giving you this holiday is cash. We want you to get something for yourself that you really want. It’s okay for you to buy something you need like a new pair of gym shoes. But if you want to put it towards your new bicycle, we would really love that.”
In this way, you haven't attached any strings to the money, but you've offered some suggestion and guidance on its use.
Set Gifting Expectations Carefully
Experts recommend you be very clear and careful about your intentions when you begin a pattern of gifting, especially if you’re giving large sums to older or adult children.
Recipients can very quickly come to both expect and, in some cases, depend on these gifts, budgeting them in for college expenses, home renovations, annual vacations, and more. If you have an intention to gift once or only do it sporadically, let your children know this so they can have appropriate expectations.
Understand the Tax Implications
The Internal Revenue Service (IRS) has very straightforward rules on gifting money. In 2018, 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 period of 2018 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.
You’ll also need to know about 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 kids who happen to be in lower tax brackets.
The first $1,000 of unearned income, such as capital gains, interest, or dividends in a child’s account incurs no tax liability. The next $1,000 is taxed at the child’s tax rate, and anything over $2,000 in unearned income receives taxes at the parent’s rate. If you’re planning on investing that cash gift, understand the tax implications if the investment pans out.
Gift Today for Tomorrow
A gift of money has particular value when it goes towards funding future dreams from college to retirement, explains Chris Chen, Wealth Strategist at Insight Financial Strategists. But you have to invest it wisely.
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, 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 their 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.
Don’t Get Stuck on the “Appropriateness” Question
Finally, there’s absolutely no doubt that the gift of money comes with baggage. Beachem suggests you don't get hung up on it. “Don’t overthink it,” she advises. If it feels good to give it, it will feel good to get it.