Giving to Kids: How to Be Both Generous and Smart
Thinking about giving some money to your children or grandchildren for a birthday or special occasion? Every kid likes a $20 bill stuck into a greeting card, but there are other options, especially if you want your gift to keep on giving for years or decades.
Here are a few possibilities:
Savings bonds. They're the "traditional favorite," says Bankrate.com senior financial analyst Greg McBride, "but the returns right now are very uncompetitive." Also, savings bonds come with penalties for early withdrawal, which could spell trouble if your child or grandkid has unexpected expenses over the next several years.
Custodial accounts. If you like the idea of a nest egg, consider creating a custodial account. Less complicated than a trust, the accounts allow you to set aside money for a child to receive upon reaching adulthood. The hitch? The money automatically goes to the child at an age determined by state law, typically 18 or 21, and once that happens, "the grandparents or parents have absolutely no say in how they use it," says Richard Salmen, a financial adviser in Overland Park, Kan. Another hitch: A custodial account can hurt a child's ability to get college financial aid, because the money belongs to the child.
529 college savings plans. These popular funds accrue money tax free, the way a Roth IRA does. Best of all, you're always in control, meaning you can switch the funds to another relative if the recipient fails to go to college or gets a full-ride scholarship. Many states grant tax deductions for 529 contributions. And if you're a grandparent giving to a grandchild, there's an added benefit: The money won't count heavily against him or her in getting financial aid.
Stocks. These can be great educational tools for older kids, especially if the companies strike a chord with their interests. But commissions can eat up a big chunk of your gift, especially if you're only spending a few hundred dollars. Consider brokerages like sharebuilder.com, which allows people to buy small numbers of shares without paying big fees, or look into direct-purchase plans from the companies themselves.
Stock gifts can even help keep money in the family. Tax preparer Jennifer MacMillan of Santa Barbara, Calif., suggests giving some of your own stock to your minor child or grandchild, who can sell it and avoid paying any taxes on the first $800 of investment income. "It's a way to give value without it costing anybody anything," MacMillan says.
IRAs. You can create an individual retirement account for children if they have income from a job. A Roth IRA is almost always a better option than a traditional tax-deferred IRA because kids don't pay much in taxes, Salmen says. It's a "wonderful tool," he adds. "The money could even be used for college down the road: You can pull the principal out without penalty." Under Roth rules, a child can pull out the principal after five years for any reason.
One option that most experts suggest is not a good one is giving life insurance to children unless there's a reason--like a medical problem--that might make it hard for them to get it later in life. "There are so many other better choices," Salmen says.
This story appears in the April 3, 2006 print edition of U.S. News & World Report.
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