Originally published: October 27, 2023 (distributed by Andrews McMeel Syndication)
Are you a well-intentioned grandparent who wants to share your stock-picking acumen with your young grandchildren -- and back that up with a gift of cash?
Set up a brokerage account under the Uniform Gift to Minors Act (UGMA). The account would belong to your grandchild; you would be the custodian directing trades. If you keep the gift at or below $17,000, there will be no gift-tax consequence.
The UGMA (comparable to a UTMA -- Uniform Transfer to Minors Act) is "a custodial account that allows you to give money to a minor while maintaining control over the money until the child reaches the age of majority," according to T. Rowe Price, a global investment management firm (tinyurl.com/48xeakva).
The UGMA allows you to buy stocks, bonds, mutual funds and other investments offered through the brokerage firm on behalf of your minor grandchild. Unlike a 529 plan to fund college expenses, there is no limit on how money in a UGMA is to be used, and there are no penalties to be concerned about. The grandchild gains control of the account upon reaching the age of majority, which varies state by state (see tinyurl.com/4wbksnxr).
Handling taxes on capital gains, interest and dividends ("unearned income") on the UGMA would be easy if the grandparent, as custodian, were responsible for the tax filing, but that's not the case.
This is where the Kiddie Tax enters into the picture, and the best resource on this subject is IRS Tax Topic No. 553, "Tax on a Child's Investment and Other Unearned Income (Kiddie Tax)" (tinyurl.com/4zy32s74). The bottom line: The tax liability on unearned income is the child's.
For the 2023 tax year, the first $1,250 of a child's unearned income qualifies for the standard deduction, which means that if the UGMA is the grandchild's only account, $1,250 of unearned income is tax-free. Unearned income above $2,500 is taxed at the parent's marginal income tax rate, and unearned income between $1,250 and $2,500 is taxed at the child's income tax rate (tinyurl.com/2hn6rauj).
Of course, a minor grandchild does not file his or her own tax return. Parents would use IRS Form 8615, "Tax for Certain Children Who Have Unearned Income," to file a return for their child (tinyurl.com/y6k9d4a2).
However, instead of filing Form 8615, the parents have an option of including their child's unearned income on their own tax returns by filing Form 8814, but only if the child's unearned income is less than $12,500 in 2023.
If the parents of the child aren't crazy about UGMAs but love 529s as a way of saving for their child's future education, there is a possibility of turning that UGMA into a 529, but the grandparent would lose the ability to buy individual stocks.
As a reminder, a 529 account is considered a qualified tuition program "that allows a contributor either to prepay a beneficiary's qualified higher education expenses at an eligible educational institution or to contribute to an account for paying those expenses," quoting IRS Tax Topic 313 (tinyurl.com/mr2mw6hz).
How would a transfer of a UGMA to a 529 work? According to a Fidelity Investments spokesperson, that would require the sale of the assets in the UGMA to free up cash to send to a 529 plan, as "all contributions made to a 529 must be in cash -- whether they are coming from a UGMA/UTMA or not."
A grandparent could liquidate a UGMA account to open a new UGMA (or UTMA) 529 account for the grandchild, or the grandparent could contribute the cash to a UGMA 529 account opened by the parents, according to the spokesperson.
Here's a word of caution: Each taxpayer's situation is unique. Be sure to check with your tax adviser before taking any action that results in tax consequences.
On another note: The 2023 national 401(k) Champion competition, which I sponsor, recognizes those 401(k) participants who understand the value of their 401(k)s enough to encourage friends, family and co-workers to learn about retirement security. If you would like to compete for the title of 401(k) Champion, apply at 401kchampion.com. There is no cost. This is a project I fund in my role as a proponent of financial literacy education.