Most parents with the ability to give money to their adult children plan to do just that. But it's not only the tax implications of gifting that parents must consider before writing a check or creating a trust.
The timing, amount and method of gifting to adult children can have long-term effects on a family's dynamic and an adult child's future. While gifting is a generous gesture, it can also spell disaster for parents' own finances and retirement plans if not thoughtfully considered. Adding to the complexity of lifetime gifting and inheritance planning are ever-changing tax and estate laws which could turn even the best of plans into costly burdens for parents and children alike.
In 2021, parents can each take advantage of their annual gift tax exclusion of $15,000 per year, per child. In a family of two parents and two children, this means the parents could together give each child $30,000 for a total of $60,000 in 2021 without filing a gift tax return. If the same family were to give beyond this exclusion amount, the parents would need to file a gift tax return and use a portion of their lifetime gift tax exemption, which currently sits at $11.7 million and is subject to change.
"There's a lot of spending going on in Washington, and when that happens Washington looks to raise revenue," says Kevin Hindman, managing director with retirement and personal wealth solutions at Merrill Lynch Wealth Management. "There's been across the board concern around all tax rates, whether it's income tax, capital gains tax, and I think one of those areas that's likely to be targeted -- and there have been various tax proposals -- is raising taxes on the transfer of wealth either during lifetime or at death."
"If you're concerned about that lifetime exemption of $11.7 million being reduced," he says, "you've got a big decision to make."
Meet Your Retirement Needs First
Decisions around when and how to give may best start with a clear look at parents' current financial situation.
A 2018 Merrill survey found that 79% of parents support their adult children, which might include covering cellphone bills, higher education costs, down payments on a first home and wedding costs. While common, supporting and giving money to adult children can come at the detriment to parents' retirement plans, particularly if unexpected emergency or medical costs arise.
"Create a balance of what you consider," Les Kotzer, wills attorney and author of "The Wills Lawyers: Their Stories of Money, Inheritance, Greed, Family and Betrayal." "Make sure you're not depleting your assets to the point of suffering or risking your money, giving it all away such that your wife or husband has nothing to live on when you're gone. You have to weigh it and weigh how your kids are going to react to it."
Choose a Method of Gifting
Parents can give money to their adult children in many forms:
-- Lump sum of cash, which may or may not be earmarked for a particular expense.
-- Cash paid in installments.
-- Transferred investments.
-- Contributions to a child's retirement account.
-- Contributions to a 529 plan whether for an adult child's education or a grandchild's education.
-- Creation of a trust fund.
-- At-death transfers.
Choosing the best method for you and your family depends on your financial situation and the circumstances and personalities of your children.
"There's general gifting and letting them decide how they're going to spend it, save it, invest it, and those are great tools for a parent to instill financial learning for a child who may be early in their career," Hindman says. "But then it's also the unexpected things that come up: a child's credit card debt, educational expenses, they might need to take a job and move to a new location and they need funding to make that transition. Gifting can take a lot of forms."
Some parents may desire more control over how a gift of money to an adult child is spent, and as a result giving through a revocable trust may be the best option. Others may feel comfortable gifting in large lump sums.
"You don't want to create the bank of mom and dad. Be careful of creating a precedent," Kotzer says. "You have to know your family. There's no generic message that when your child turns 25 you give them $5,000. You have to look at their needs, at who is actually using this money and for what?"
Weigh Lifetime Gifting vs. an Inheritance
Timing a large gift of money can be important for tax purposes and in the lives of the parents and children involved. So long as parents have determined they are able to comfortably give during life, Kotzer says many do.
"If you have it and you don't need it and your kids are going to get it anyways, isn't it better to share it now?" Kotzer says. "There are people who hoard money and just don't want to let go."
Those parents who choose to do most of their gifting in the form of an inheritance should work closely with an estate planning attorney to protect against unwanted outcomes, such as an extended and costly probate process. Darian M. Butcher, probate attorney and founder of Butcher Law in Massachusetts, says family communication is key to a successful plan.
"Make sure you have an estate plan you revisit with your planner that covers not just where things go but why," Butcher says. "Make sure the people who are going to be inheriting from you know that. There's nothing worse than getting to the probate process than having a bunch of people who are surprised."
Such plans need to be regularly updated and maintained to ensure a parent's wishes are properly executed.