A Guide to Gifting Money to Your Children

Most parents prioritize generosity, responsibility and fairness when it comes to giving money and passing on wealth to their children and grandchildren. But, particularly in cases where there are substantial family resources, being strategic about giving can also be important.

Determining the best way to pass money to your heirs largely depends on the ages of your children and your objectives, said Joe Goldman, a senior wealth planner with City National Bank in Beverly Hills.

“It's important to understand what the family wants to accomplish, such as funding for education, leaving an inheritance, or protecting assets, and to determine the best timing for those goals," said Goldman. “For example, the family may want to set aside a certain sum today but intend for it to be used at some point in the future."

While one main goal of passing down wealth may be to provide financial support for the family for generations to come, families should understand the tax implications of such giving in order to achieve their long-term wealth plans.

 

Tax Implications for Gifting Money 

It is important to note that gifts of money or property may be subject to federal gift or estate tax, depending on the value of the gift and the way it is given. If tax liability is incurred, it is the donor - not the recipient - who pays the tax. Estate tax, if required, is typically paid from the deceased donor's estate.

The current top federal estate and gift tax rate is 40%. Gift tax is applied during the donor's lifetime while estate tax is imposed upon the donor's death.

Gifts from a donor in excess of $18,000 within one year must be reported to the IRS using Form 709, even if the donor has not exhausted his or her lifetime gift tax exemption.

In 2024, the lifetime gift tax exemption is $13.61 million. The IRS will use the information reported on Form 709 to update the donor's remaining gift tax exemption and determine whether federal estate taxes are due after the donor passes away. IRS Form 706 addresses federal estate taxes upon an individual's death.

Some states also impose state gift or estate taxes, which may apply in addition to the federal tax.

“Estate planners can establish trusts in different states to take advantage of favorable jurisdictions," Goldman said. “In addition to having different income tax rates, states have various rules about how long a trust can last. For example, in California, a trust may only last a limited period of time, but in Delaware, a trust can be set up to last indefinitely."

Twelve states and the District of Columbia currently collect estate taxes on residents, with exemption levels ranging from $1 million to $13.61 million.

How Much Money Can Be Gifted to Children in 2024?

For the year 2024, the annual gift tax exclusion amount is $18,000 per recipient, including children. This means an individual can gift up to $18,000 to any number of people within a calendar year without triggering the need to file a gift tax return or affect their lifetime gift tax exemption. Married couples can combine their exclusions to give a total of $36,000 per recipient annually.

What Happens if You Gift More Than the Limit?

Gifts exceeding the $18,000 annual exclusion must be reported on IRS Form 709. This excess counts toward the donor's lifetime gift tax exemption. Once the exemption is exhausted, additional gifts may incur gift tax, which the donor must pay.

As of 2024, the lifetime gift tax exemption is $13.61 million. For married couples, this limit increases to $27.22 million.

What Gifts Need to Be Reported?

The IRS requires you to file Form 709 if you make gifts of cash, property or other assets that exceed the annual exclusion limit. This form helps track gifts that might impact your lifetime gift tax exemption and ensures proper taxation where applicable.

According to the IRS, a gift is defined as “any transfer to an individual, either directly or indirectly, where full consideration (measured in money or monetary value) is not received in return.” This means that any transfer without receiving equivalent value must be reported.

Examples of gifts that generally need to be reported include:

• Down payment for a home
• Direct cash gifts for education or personal expenses
• Real estate or property transfers
• Contributions to a 529 plan for someone other than yourself or your spouse
• Loan forgiveness

If you're unsure if you should report a gift, be certain to speak with a financial professional about it.

 

Note the Different Trust Options

Trusts can be written for minors or for adults, with the distribution of funds outlined in the trust agreement.

“A trust is a good vehicle to clearly establish your intent for your gift while also functioning as a means to reduce the size of your taxable estate for the future," said Goldman. “You can limit distributions to pay for educational or health care needs, or you can establish a timeline for distributions based on age or specific events, such as purchasing a home or starting a business," he said.

Based on your goals and circumstances, there are a variety of techniques that you should consider with your tax, legal and other advisors. Options that are most commonly used today are below.

Intentionally Defective Grantor Trust (IDGT)

This is a popular strategy mainly used in a low-interest-rate environment, said Goldman. An IDGT is a type of irrevocable trust that is typically used to transfer assets to the grantor's descendants. With an IDGT, the grantor remains liable for the income taxes generated by trust assets, which effectively allows the trust assets to grow income tax-free.

With this type of trust, you may sell assets to the trust in exchange for a promissory note that pays market-rate interest. The strategy is most effective when the trust assets appreciate at a rate that exceeds the applicable interest rate.

“The IDGT makes a lot of sense if the asset is expected to appreciate, such as stock in the family business that is anticipated to be sold someday," said Goldman. “The trust can sell the assets to a third-party buyer and the proceeds can be retained and distributed per the trust's terms."

Grantor Retained Annuity Trust (GRAT)

A GRAT is an irrevocable trust in which you transfer investments or property in exchange for an annuity based on the value of the assets, said Goldman. When the GRAT term ends, the remaining assets pass to the beneficiaries without incurring gift or estate tax.

In a low-interest-rate environment, or when assets such as stocks are depressed in value, a GRAT can be an opportunity to make a gift at a low tax cost that will appreciate for your beneficiaries.

 

Purposeful Planning

Purposeful planning is an approach to estate planning that involves all your beneficiaries and improves the possibility that wealth will last for multiple generations.

"An important element of gifting money to children is to prepare them to manage their gifts," said Goldman. “You can set up all the sophisticated trusts you want, but if future generations are not prepared to handle the money, then the benefit of the wealth could be lost."

This type of planning includes financial literacy training and discussions of goals and values among all family members. Philanthropy and the responsibility of wealth management are typically part of the discussion as well.

“Gifting money in your lifetime rather than through your estate has multiple benefits," said Goldman. “The assets can appreciate for more time - which is good for your beneficiaries - and you're moving the money out of your taxable estate. It's also an opportunity to discuss your values and teach your children and grandchildren how to manage their wealth."

With the expertise of wealth and estate planners, sharing the wealth with your descendants can establish a foundation of financial stability for generations.

 

Gifting Money to Adult Children

When gifting money to your adult children, it's important to distinguish between direct and indirect financial support and understand the tax implications associated with each method. Unlike minor children, who may still be dependents, adult children typically have their own financial responsibilities.

When gifting money to adult children, consider:

• Direct Gifts: Give cash or property up to the annual exclusion limit to avoid gift tax filing. Report larger gifts on IRS Form 709.
• Funding Education or Buying a Home: Help with student loans or home down payments.
• Establishing Trusts: Use trusts to manage and protect assets, support financial needs over time and potentially reduce estate taxes.

Is Your Child Still a Dependent? 

If your child is still classified as a dependent, different tax rules apply compared to gifting to independent adults. According to the IRS, a dependent child is typically under 19 years of age, or under 24 if a full-time student, and reliant on their parents for more than half of their financial support during the year.

Here’s what to keep in mind:

• Direct payments for tuition or medical expenses are not considered gifts.
• For other financial gifts, including gifting property to children, consider using custodial accounts. Custodial accounts (UGMA or UTMA) allow you to gift money or property without immediate tax implications, with the assets managed by a custodian until your heirs reach adulthood. 

If you gift substantial sums to a dependent child, make sure that the gifts do not inadvertently alter their dependent status, which could affect your eligibility for certain tax benefits, such as the Child Tax Credit.

What is Not Considered a Gift by the IRS?

Not all financial transfers are classified as gifts by the IRS. Several types of payments are specifically excluded from being treated as gifts, and thus are not subject to gift tax rules.

Things the IRS might not consider a gift include:

• Payments for services, such as wages or professional fees
• Payments for life or health insurance premiums
• Direct payments to educational institutions for tuition
• Direct payments to healthcare providers for medical expenses
• Payments made directly to landlords or housing providers for rent
• Payments made to fulfill legal obligations like child support or alimony

 

Gifting Money to Younger Children or Grandchildren

Gifting to younger children or grandchildren follows similar tax rules as gifting to adults. You can gift up to the annual exclusion amount per child ($18,000 in 2024) without triggering gift tax. For larger gifts, use the lifetime exemption and file IRS Form 709. Consider using custodial accounts like UGMA or UTMA to manage gifts until the child reaches adulthood, ensuring the funds are used appropriately for their future needs.

Open a 529 Plan

A 529 plan is a tax-advantaged investment account designed to encourage college savings. Whether you want to fund a private education throughout your child's lifetime or pay for higher education, a 529 education savings account could be a powerful option, said Goldman.

Anyone can open a 529 savings account on behalf of a beneficiary, but typically they're opened by parents or grandparents.

The funds in the account grow tax-deferred and, as long as the funds are used for qualified educational expenses, such as tuition, books, supplies, and room and board, withdrawals are tax-free.

There are many 529 programs that are administered by state governments with varied rules. For instance, some states provide a state income tax deduction or credit for 529 contributions.

And while annual contributions to 529 plans are unlimited, they also are subject to gift tax limits. Each state sets an aggregate limit for 529 plan balances.

In California, for example, the aggregate 529 plan balance limit is $529,000. “Donors can gift up to $18,000 each year to each beneficiary under the annual gift tax exclusion, including into a college savings fund for that beneficiary," said Goldman. “Each donor can give that much to a descendant, so a married couple can contribute $36,000 per child or grandchild to a 529 plan in one year, tax-free."

In addition, contributions to a 529 plan can be frontloaded by gifting five years' worth of annual exclusion gifts at once without impacting the gift tax exclusion, said Goldman.

“Frontloading the plan, especially if your child is young, offers the advantage of giving the money more time to grow," said Goldman. “At the same time, you're potentially pulling that money out of your taxable estate."

For example, Goldman said a grandparent with five grandchildren could deposit $90,000 per grandchild, and thus reduce their estate by $450,000, or a combined $900,000 for both grandparents, without any impact on their gift tax exemption.

The funds in a 529 plan may be used to pay for college or graduate school. In addition, up to $10,000 per year can be withdrawn tax-free to pay elementary, middle and high school tuition at private and parochial schools.

Other Gifting Exceptions

In addition to funding a 529 tuition plan, there are additional tax-advantaged ways to provide funds to your descendants, including giving to:

• Educational Institutions: “Donors can pay tuition directly to an educational institution rather than giving the money to their descendants, and that is not considered a gift," said Goldman. “Certain qualified medical expenses also can be paid directly and not be considered a gift."
• Dependents: Giving money directly to your dependent children also is exempt from the gift tax. “You can give money to your minor children with a Uniform Gifts to Minors Account (UGMA) or a Uniform Transfer to Minors Account (UTMA), but you have less control over what they do with the money when they come of age," said Goldman. “Depending on what state you're in, they may be able to access the money when they're 18 or 21 and use the cash for anything."

Sometimes people erroneously think that adding their adult children's names to their bank accounts can be a way to avoid estate or gift taxes. However, this is not necessarily the case.

“While that might seem like a simple thing to do, adding your adult child's name to your accounts would count as a gift," said Goldman. “If you're audited, then that would count against your gift tax exemption."

In addition, Goldman explained, once a adult child is added as a joint owner to an account, he or she can withdraw some or all of the account, or the account may be subject to their creditors. If the child goes through a divorce, the account may be included as part of their overall assets. If the child were to die, the account would potentially be included in the child's estate.

Generation-Skipping Transfer Tax

An additional 40% generation-skipping transfer (GST) tax may be imposed on gifts or inheritances transferred to a "skip" person, such as a grandchild or unrelated individual that is at least 37 ½ years younger than the donor, said Goldman.

Similar to the federal estate tax exemption, donor can use their federal GST tax exemption ($13.6 million in 2024) when making gifts to skip persons.

Need to discuss your wealth plan with an advisor and wish to find one? Get in touch with a City National advisor today.