Dangerous Gifts

Apr 24, 2022

Sometimes, getting a pile of money can do more harm than good. The younger a gift recipient is, the greater the risk the money is wasted, or, even worse, the money is spent on drugs or to facilitate bad life choices. Unfortunately, the top three gifting options people choose for younger recipients, usually children and grandchildren, can put not only the money but the person at risk. The top three choices are 529s, custodial accounts, and gifting trusts, but a fourth option for revocable living trust clients provides the most protection and flexibility in the vast majority of situations.

Education tends to be an important objective with parents and grandparents, so to support educational goals they want to gift money into 529 plans when the kids are younger. Depending on the state, there are some tax advantages such as tax deductions for contributions and no taxation on growth. (North Carolina does not have a deduction for contributions). However, that is weighed against the fact that the beneficiary is not required to use the money for educational purposes… they can take the money, accept a hit in taxes and penalties, and then use the money to party. When looking at that possibility, some of my clients have concerns that the beneficiary may not use it the right way.

The second popular gifting option is putting the money into a custodial account. This has fewer tax advantages, but it has greater risk of being wasted because there are no major penalties or major taxes due when the money is withdrawn. Custodial accounts are generally “pay as you go” in terms of taxes and growth. Once the beneficiary reaches the age when they can take control of the account, there is nothing stopping them from using the money for whatever they want.

The most effective way to actually gift money, and therefore get it off the giver’s balance sheet for estate and other taxes, is to gift it to a Gift Trust. The beneficiary or beneficiaries are set, the trust is irrevocable and not changeable, there is an independent trustee separate from the giver and the beneficiary, and the money remains protected. In most Gift Trust cases that my firm deals with, the trustee is given broad discretion to use the money for the beneficiary however they see best, and there is a much greater age when any leftover assets are given outright to the beneficiary. It is just known to the trustee that the givers would prefer the money to be used on education.

While this sounds great, the cost of such trusts and giving up control of the money by the giver often outweigh by limited advantages. This is because the vast majority of people do not have an issue with potential estate taxes that compels them to make the gifts. Most of our clients simply would like to support the children or grandchildren, and taxes are not a motivation as much as a potential side benefit. The most flexible solution for our revocable living trust clients is to set up individual accounts for each gift recipient in the name of the trust, manage the accounts in their own trust, and deciding whether or not to pay for certain expenses or give money to the beneficiary. They can also have their trust direct the specific account go to the specific beneficiary upon death still subject to the trust’s age and other restrictions. Yes, it’s not technically a completed gift, but most of our clients don’t need them to be to reach the goal of helping beneficiaries with educational expenses.

Check out the YouTube video on this topic at: https://youtu.be/2VbbLN0dZRs

Check out the full FREE webinar: How to Save Tens of Thousands of Dollars by Effectively Planning for a Special Needs Beneficary at www.SpecialNeedsPlanningWebinar.com 

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