The Best Gifts for Kids Who Aren’t Your Own
(Bloomberg Opinion) -- A common reaction to hearing about a pregnancy is to say congrats and perhaps send a onesie. But there are other ways to celebrate and support newly expecting parents.
When my sister-in-law announced her pregnancy last fall, my brain leapt to how my husband and I could save and invest for our future nephew. Savings bonds? Those feel like a relic of the past. A straight up check? Individuals can gift up to $15,000 to someone without triggering tax consequences. As a couple, that means you could gift $30,000.
As I’ve said before, there are plenty of reasons to pass on an inheritance early, especially to help build generational wealth in your family. This is particularly relevant for those who elect to stay child-free, but have nieces, nephews, godchildren and other young loved ones in their lives.
If you’re strategizing for the long term, here are the main options to consider.
Focus on education. 529 plans are often heralded as the best way to set aside money for a child’s schooling. The education savings plans often get the most press because they offer a bit more flexibility compared with prepaid tuition plans. 529 plans are also tax advantaged and can be used for elementary or secondary school education expenses in addition to college.
As a New York State resident, I could open up a 529 plan for my nephew and be eligible to deduct up to $10,000 annually from my New York State taxable income (because I’m married filing jointly; it’s $5,000 for single taxpayers).
When it comes to gifting to a child that isn’t your own, however, things do become a tad more complicated. You’d need access to the child’s Social Security number to open up an account. Needless to say, you should discuss any plans with the parents first.
There are also a few potential catches with the 529 plan approach. For one, the funds must be used for qualified expenses in order to be tax advantaged. Generally, these are education-related expenses. But if my nephew elected to not attend college and I didn’t use the funds for primary or secondary school, then I’d have a few choices. Pulling money out for a non-qualifying expense would trigger the need to pay taxes plus a 10% penalty.
Luckily, there is no phase out nor age limit to a 529 plan being used, and I could switch the beneficiary to another eligible family member
But another catch is financial aid. The funds in your non-parent 529 plan would be considered the student’s income after distribution, which could impact the calculation for their eligibility for financial assistance. In this case, 529 plan withdrawals are calculated similarly to a custodial account.
Instead of creating your own account for a minor, you could just regularly contribute to a 529 plan that’s been set up by the parents. You probably won’t get a potential tax deduction, but it could be a better situation in terms of financial aid for the child. Think about it as a gift just like birthday or holiday presents.
If I open a 529 plan and my nephew ends up with a college scholarship, then I could take a non-qualified withdrawal for the amount of the scholarship without penalty — but still pay taxes. There are also exceptions to the penalty if he were to attend a U.S. military academy or become incapacitated.
Consider more advanced options. Custodial accounts like Uniform Gifts to Minors Act (UGMA) or Uniform Transfers to Minors Act (UTMA) give far more flexibility in terms of investment options — which would be more pleasing to a savvy investor — but there’s no control over the funds once the child turns 18 or 21 depending on your state’s rules. These also count as student assets in terms of calculating financial aid, which could screw up the amount of assistance the child is then eligible to receive. So if you’re not providing enough to pay for college outright, this should be a discussion with the parents.
Personally, I’m partial to the idea of gifting fractional shares of products and companies he’s interested in as he ages. This would need to live within a custodial account, but it feels like a more engaging way to get him interested in learning about investing than just telling him we contributed to an account. As he ages, I’d want to sit down and teach him some simple investing principles.
The gift of financial literacy is a powerful one. It also would be less overwhelming for non-experienced investors to have someone else handle the actual investments in the account.
Gift some knowledge. Another idea is to help a parent set up appropriate accounts to start saving and investing for their child’s future. You could gift your loved ones a session with a certified financial planner, especially if there are unique circumstances in their life that make financial planning a bit more complicated.
Or perhaps you play the role of tutor. Setting up for a brokerage account can be overwhelming for those who are experiencing it for the first time. Taking an hour of your time to sit in person and walk them through the experience is a gift too. It also keeps them from putting it at the bottom of the never-ending to-do list we all have running.
At the end of the day, my and my husband’s opinions about the best way to gift money to our nephew doesn’t matter nearly as much as his parents’ preferences and boundaries. He isn’t my child and it’s completely up to their discretion how much and in what way my husband and I can invest for his future. So if you’re not sure where to start, try asking the new parents.
This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.
Erin Lowry is the author of “Broke Millennial,” “Broke Millennial Takes On Investing” and the forthcoming “Broke Millennial Talks Money: Stories, Scripts and Advice to Navigate Awkward Financial Conversations.”
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