Gifting to Your Kids – 4 Strategies You might not have Considered

One of the most fulfilling roles as an advisor at Stratos Private Wealth (SPW) is helping our clients use their money as a tool to do the things in life they enjoy most. For many of our clients, that means developing creative, tax-efficient strategies for gifts to their loved ones. We break down the strategy and possible tax benefits involved with gifting stock to your family, frontloading gifts through intrafamily loans, kickstarting your child’s retirement savings, and increasing college savings.

1. Giving the Gift of Appreciated Stock

We’ve seen parents gift money to their kids and grandkids by writing them a check. But gifting appreciated investments can be a tax-efficient method, especially if you hold a significant amount of stock in the same company that writes your paychecks. First, you’re potentially reducing unrealized capital gains. Second if your kids or grandkids have lower income, there is a possibility that they may be able to sell the gifted stock with little to no capital gains implications.

Consider the follow scenario:

For 2024, if the gift recipient is a single taxpayer with taxable income of $44,625 or less, he or she might pay 0% in federal capital gains tax[2] Married taxpayers filing jointly with taxable income of $89,250 or less might also benefit from the 0% capital gains tax rate*. So, although you’re passing unrealized gains when gifting appreciated stock, the lower tax bracket could
mean they can realize those gains for little or no tax consequences.

Oftentimes clients ask SPW advisors if they should gift their company stock with large unrealized gains. From our experience, these gains are acquired through equity compensation vehicles like Employee Stock Purchase Plans (ESPPs), incentive stock options, and restricted stock options (RSUs)[1] It’s important to keep in mind that these compensation vehicles can have their own tax rules. For example, if you gift stock from your ESPP, the discount you received at the time you purchased the stock may be added to your taxable income in the year your gift is made. These rules underscore the importance of working with financial and tax advisors who have experience with equity compensation so be sure to leverage their experience.

[1] Learn more about ESPP here: htps://stratosprivatewealth.com/blog/espp

If you have underperforming (position with an unrealized loss) stock, depending on your tax situation it may make sense to sell at loss and gift the cash proceeds to your kids. For example, if you have a large tax liability from recognizing significant gains in the current year, selling stock for a loss may help you offset some of those gains and could reduce your tax liability.

Getting Investing Started Early

A custodial account is a taxable account established and controlled by a parent or other adult for the benefit of a minor. If you’d like to retain control of the investments after your kids turn 18 (or 21 in some states), consider establishing a trust account that can put some restrictions on when your kids or grandkid can access those funds. SPW suggests consulting with your 
attorney about the appropriate steps to take when setting up accounts for your children.

Once you’ve opened a custodial account, you can transfer stock into this custodial account. It’s an in-kind transfer, not a sale, so the stock doesn’t trigger capital gains. Essentially, the unrealized gain (original cost basis) is transferred along with the gift. If the position you’ve gifted is a part of your investment strategy that you’d like to keep, you can purchase the same stock in your own portfolio, and you’ll have reduced your unrealized gains. Before gifting to your kids, you may consider leveraging both your annual gift tax exclusion ($18,000 to any one person free of gift taxes in 20242) or review opportunities for larger gifts by leveraging your lifetime exemption amount. Checkout our Gifting 101 article to learn more about gifting rules and possible benefits to consider. Please note, we are not tax professionals and do not provide tax advice so please contact the appropriate professional regarding your specific situation.

[2] Source: https://www.irs.gov/newsroom/irs-provides-tax-inflation-adjustments-for-tax-year-2024

2. Help Kids Buy Their First Home Through Intrafamily Loans With Yearly Debt Forgiveness

Given the recent appreciation of the housing market[3], particularly in San Diego and Southern California, SPW advisors are frequently asked how parents can help their young adult children or grandchildren buy their first home. While many parents may think to make a large upfront cash gift, lending your kids money may be more tax efficient. This involves making an intrafamily loan from the “Bank of Mom and Dad.” For this strategy, you effectively act as the lender to your kids. Each year, you can “write off” or “forgive” your kid’s debt up to your $18,000 annual exclusion amount per person ($36,000 if married filing jointly for 2024)[4]. So long as you don’t forgive more than your annual exclusion, this could be a tax-free gift. This is a way to give your kids a large upfront gift in a single year without triggering gift taxes or affecting your lifetime exemption amount.

Here’s an example to explain:

Your daughter, Jill, and her husband, Bill, need $400,000 to buy a home. For an intrafamily loan, according to the IRA tax code[5], Jill and Bill must pay you a minimum interest rate. For simplicity, let’s say that rate is 3%, which comes out to $12,000 per year [$400,000 x 3%]. Since you and your spouse may gift them up to $72,000 per year [$32,000⁴ annual exclusion x 2 persons] without tax implications, you can simply choose to forgive the $12,000 of annual interest and $60,000 of principal on December 31st. In this scenario, the $72,000 of debt and interest forgiveness per year counts as a tax-free gift that won’t eat into your lifetime exemption amount. Make sure your loan forgiveness is clearly documented in writing. If your financial plan can’t afford to gift up to $72,000 per year, another option would be to lend Jill and Bill $400,000 through an interest-only loan. Again, let’s assume an interest rate of 3%. In this case, you can forgive the $12,000 of interest each year and agree on some type of principal repayment plan.

If you are considering making an intrafamily loan, SPW recommends reviewing your financial plan with your advisor to see how much you can afford to give. You can also work with SPW advisor who will help lay the foundation of how the arrangement might work, positioning you to then consult with your estate planner and tax professional to make sure the proper legal documents are drafted and signed.

This is a hypothetical, fictional example of potential client scenario. These are not real people but, these situations are used to provide clarity on potential tax considerations others may be considering.

[3] as of the date of this publication. [4] Source: htps://www.irs.gov/newsroom/irs-provides-tax-inflation-adjustments-for-tax-year-2024 [5] Source:htps://www.investopedia.com/terms/a/applicablefederalrate.asp

3. Retirement Savings

Getting a full-time paycheck and access to a 401(k) plan and other employer benefits is an adult milestone. But for the first few years, it’s difficult to set aside enough to even get the corporate matching funds[6]. While learning to live independently and saving for retirement are important, it's key to start saving early so you can improve your retirement outcome. 

[6] A 401(k) match is when your employer contributes money in your 401(k) account to reflect the contributions you've made out of your compensation.

Employer 401k

While you can’t make direct contributions into a child’s 401(k), you can gift them money with the intention of them saving more for retirement. The hope would be that they use money saved on paying routine living expenses and contribute to their 401(k). For example, if you gift your child $18,000 per year to help cover their rent, you in turn encourage them to contribute that same amount to their 401(k) or IRA accounts. This allows parents to retain some control over the funds, and to have the satisfaction of knowing they are helping build for the future. The goal is to lower the kids' taxable income, and there aren't tax consequences for the receipt of the gift, but 401(k) contributions are made with before-tax dollars.

Health Savings Accounts (HSA)

If your child has access to a Health Savings Account (HSA), you may also consider putting your gift towards their HSA contributions. In 2024, you may contribute as much as $4,150 into his HSA[7]. Participants may qualify for a tax deduction and investments grow on a tax-deferred basis. They can take advantage of tax-free distributions in retirement if they are used to cover 
approved healthcare expenses.

Because the IRS does not require to take HSA distributions in any set timeframe, the strategy suggests your child covers their out-of-pocket healthcare costs before retirement using money in their bank accounts. If they do this, they could retire with an investment account set aside to cover healthcare costs in retirement. To learn more about the tax-benefits of HSAs, checkout our article – Health Savings Accounts: A Simple Tax Break for High Earners.

Custodial IRA

You may open and fund a Custodial IRA (an IRA owned by a minor but controlled by an adult custodian) for any child, regardless of their age, if they have earned income. In 2024, you can make a maximum IRA contribution of $7,000 per year[8] but may not exceed the child’s earned income. These contributions can be made by anyone (a parent, family member, friend, etc.).

Some early earners may not benefit from tax-deductible Traditional IRA contributions, so funding a Roth IRA could make sense. There’s no immediate tax break associated with Roth contributions, but investments in a Roth IRA grow tax-free[9] and are not subject to required minimum distributions like Traditional IRA funds. To learn more about all the benefits associated with a Roth IRA, you can refer to our article – Roth Conversion

Or Any Other Tax-Advantaged Savings Vehicle

While the examples above are common strategies we see practiced, your kids might have access to other tax-advantages savings options through their employers or other means. Although their personal cash flow might not allow for saving, you could help supplement their day-to-day expenses through a gift. In turn, the hope is they can direct a portion of their paychecks to tax-advantaged retirement accounts. The time-value of money and tax advantaged nature of these options can compound by the time they retire. 

[7] Source: htps://www.fidelity.com/learning-center/smart-money/hsa-contribution-limits [8] Source: htps://www.irs.gov/newsroom/401k-limit-increases-to-23000-for-2024-ira-limit-rises-to-7000 [9] If you satisfy the qualified distribution requirements. IRS Source: htps://www.irs.gov/retirement-plans/roth-iras

4. How Can I Maximize 529 Plan Contributions?

As tuition costs at all education levels continue to rise, developing an effective savings strategy to fund your child’s education has become increasingly important. While many individuals may think they can only fund a 529 plan up to their $18,000 annual exclusion amount per year in 2024 ($36,000 for married taxpayers filing a joint tax return⁴), the IRS provides a method to frontload five years of contributions into 529 plans in a single tax year.

This means a single taxpayer may gift up to $90,000 [$18,000 annual exclusion x five years] in a single year to any one beneficiary free of gift and estate taxes. For married taxpayers filing jointly, the maximum one-year contribution is $180,000 [$36,000 annual exclusion x 5 years⁴]. On top of that, the IRS says your taxable estate can be reduced by the amount of your 529 contributions. This could help reduce your assets subject to estate taxes at the end of your lifetime.

Since the IRS treats five-year funding as if you and your spouse gave $36,000 per year for the next five consecutive years, it’s important to understand that you may not make any additional tax-free gifts to your children for the five years following your frontloaded 529 contributions. These contributions must also be reported on a gift tax return (Form 709)[10] for the next five years. Before filing your taxes, make sure your CPA knows about your 529 contributions.

 [10] Source: htps://www.irs.gov/forms-pubs/about-form-709

How can Stratos Private Wealth Help?

As part of our service to clients and in conjunction with your tax and legal professionals, SPW will evaluate the tax-efficiency of your current gifting and estate planning strategy. We can look at your full financial picture and show you the tax efficient ways of transferring wealth to loved ones without impacting your lifestyle or future needs.

SPW advisors can work directly with your CPA and estate attorney to help you create more advanced gifting and estate planning strategies as needed.

If you’re looking to make significant, thoughtful gifts to your loved ones in a tax-efficient way, please contact SPW. While we are not tax advisors, we will provide high-level consultation that can be evaluated with your CPA and estate attorney and then put into action (if deemed to be advantageous based on your unique situation).

*As always, tax rates and limits are subject to change.

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Disclosures

Stratos Private Wealth is a division through which Stratos Wealth Partners, Ltd. markets wealth management services. Investment advisory services offered through Stratos Wealth Partners, Ltd., a registered investment adviser. The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. Stratos Wealth Partners and its affiliates do not provide tax, legal or accounting advice. 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