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 gadgets. 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 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; 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 may not 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 understand their $1s from their $100s should know that they won't get to hang onto that hundred dollar bill. It’s simply too much money to entrust to younger kids.
If you want to give a cash gift, 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 you can use to teach your children how to use gift money is to explain why they are receiving it, and then give 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 if you are 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 come to both expect and, in some cases, depend on these gifts. They might start budgeting for them for college, home renovations, annual vacations, or other expenses. 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 2021, you can give up to $15,000 ($16,000 in 2022) per person each year; your spouse can do the same, which allows for a joint gift of $30,000 per person annually ($32,000 in 2022). Amounts more than that have to be reported to the IRS, and count toward your lifetime gift exclusion (which is substantial). The 2021 IRS lifetime gift exclusion allows you to give away $11.7 million ($12.06 million in 2022) during your lifetime or at death before incurring tax.
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 $23.4 million in lifetime gifts ($24.12 million in 2022). 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 estates 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 taxed if it is high enough and if they are required to file.
You’ll also need to know and understand the kiddie tax, especially if you want to use the gift as an investment lesson. The IRS established this provision to prevent well-to-do parents in high tax brackets from trying to shelter assets and money in the names and custodial accounts of their children who happen to be in lower tax brackets. Gifts of cash aren't taxed as unearned income, but any interest earned from assets given as gifts (such as securities or real estate) is unearned income, and you or your child will have to pay tax on it.
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 correctly to reduce tax implications, however.
If your child works, you can contribute to a Roth Individual Retirement Account (IRA) on their behalf in an amount equal to their income, up to the yearly cap of $6,000. The gifts count as part of the $15,000 ($16,000 in 2022) you’re allowed to give them annually before reporting.
When you make the gift of a Roth IRA contribution, you should sit down with your child and talk about investing 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, SoFi, 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 ($16,000 in 2022) 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 in the following years, tax implications, or hard feelings from those that receive less or none at all. But, 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.
Frequently Asked Questions (FAQs)
What is the tax form to use when gifting money to children?
Gift taxes are reported on IRS Form 709.
When your child is given money as a gift, can they use it as they see fit?
Money gifted to children becomes their property. They can use it as they see fit. Of course, if you're the parent of the child in question, you have some level of control over what your child does (or doesn't do) every day. Barring any parenting issues, money gifted to children is theirs to use as they wish.
How does gifting money to children affect Medicaid?
Gifted money is considered unearned income for the recipient. If you give a significant amount of money to a child who applies for Medicaid, the extra income could affect their eligibility for premium assistance. This will largely depend on your state's Medicaid program, so check with your state's authorities for more information.