For 2020, an individual can gift up to $15,000 to another person in a year without needing to file a gift tax return. Gifts in excess of the $15,000 limit are tracked through gift tax return filings and reduce the lifetime gift exclusion. For this year, the exclusion is $11.58 million per person but could be reduced substantially on January 1, 2026 when the current tax law expires. One potential drawback to outright gifts to minors is that once the gift is made, the funds become the property of the recipient to spend in any way he or she desires.
Another simple wealth transfer mechanism is the custodial account under either the Uniform Gifts to Minors Act (UGMA) or Uniform Transfers to Minors Act (UTMA). To establish one of these accounts, the individual transfers assets into an account that is set up at a bank, brokerage firm, or other eligible institution for the benefit of a specified minor. The UGMA account is restricted to financial assets such as cash and stocks, while the UTMA account may also hold real estate. Upon transfer of assets into the account, they immediately and irrevocably become the property of the minor, even though the contributor has discretion over how the funds are spent while the account is open. All account expenditures are required to be used for the sole benefit of the minor. Once the minor reaches the age of majority, typically 18 or 21, the child gets complete control of the assets in the account. Custodial accounts have many drawbacks including the fact that the recipient may not have the maturity or responsibility to handle the funds wisely at such a young age. The funds are considered the asset of the recipient for college financial aid purposes, and the account is irrevocable so it cannot be transferred to another family member. Furthermore, if the custodian dies before the account is closed, it is included in the deceased’s estate which would likely defeat the intended purpose of funding the account.
One alternative to the custodial account is a 529 college savings account. For this type of account, the donor contributes cash which can grow tax-free. No taxes are ever assessed on the principal or earnings as long as the funds are used for qualified expenses. Qualified expenses include tuition, books, computers, room and board, and other pertinent school expenses. If the funds are used for any other purpose, the earnings portion of the withdrawal is taxed as ordinary income and a 10% penalty applies. Under current tax law, as much as $10,000 per child per year can be used for private school tuition for elementary through high school students. There is no limit to the amount that can be spent on qualified college expenses. The lifetime maximum that can be contributed for an individual is $520,000. Contributions can also be “frontloaded”, which means that up to five times the annual gifting limit of $15,000, or $75,000, can be contributed in one year without incurring the gift tax as long as no additional contributions are made in the following five years. The contributions are a deduction for state income tax purposes only. The advantages of the 529 plan over the custodial accounts are that beneficiaries can be changed by the donor and there are no time limits on the funds must be spent. Although the plan remains the asset of the parent instead of the child for college financial aid purposes, it is treated as a completed gift and not included in the donor’s estate.
These are just a few of the many ways one can transfer wealth to his or her heirs. Please call our office with any questions.
By Cheryl DeVoe, CPA
- This material has been prepared for informational purposes only, and is not intended to provide, and should not be relied on for, tax, legal or accounting advice. You should consult your own tax, legal and accounting advisors before engaging in any transaction.