With the holiday season already upon us, everyone is scurrying to make last-minute gift purchases. One idea you might not have considered is the gift of investments. Let’s examine the ins-and-outs of purchasing investments for your friends and family.
As a child, you likely received bonds from your grandparents, but other options to consider are stocks, mutual funds and 529 contributions. Each of these can be a great gift in its own way.
But first let’s look at some general guidelines for giving investment-type gifts.
Gifting Investments — General Rules
Whatever type of investment you’d like to gift, there are some general rules that are likely to apply.
Gift Limits. There is a limit beyond which any monetary or investment gift will be subject to gift taxes. In order to avoid that, you can limit your gift to any single recipient to no more than $14,000. That is the limit for 2016.
The gift limit is per donor/per recipient. That means that you can give $14,000 to your child, and your spouse can also give $14,000 to your child — $28,000 total — and the gift tax won’t apply.
Gifts of Appreciated Assets. If you choose to give someone an appreciated investment asset from your own portfolio, the capital gains tax on the appreciation will be the responsibility of the recipient. This will little effect of course if you are making a gift of a recently purchased investment, but in cases where the asset has already appreciated in value beyond the price you originally paid for it, the effect could be considerable.
”Kiddie Tax.” The IRS has special rules for investment income for minors, commonly referred to as the “kiddie tax.” If the child’s interest, dividends and other unearned income total more than $2,000, part of that income may be subject to tax at the parent’s (higher) tax rate instead of the child’s tax rate. Alternatively, if the child’s interest and dividend income (including capital gain distributions) total less than $10,000, the child’s parent may be able to elect to include that income on the parent’s return rather than file a return for the child.
This is actually a fairly complex tax area, since there are different rules for children younger than 18 and still-dependent children between the ages of 18 and 24. If the child’s investment income exceeds the income threshold, you should discuss the tax implications of income-generating assets before making your gift.
Custodial Accounts. While you can often gift an investment directly to the recipient, there are situations where doing so using a custodial account will be either required or highly desirable. Mutual funds are an excellent example. You can set one up under the Uniform Gift to Minors account or the Uniform Transfer to Minors account, commonly known as UGMAs or UTMAs. These can be brokerage accounts for your kids, and they can be particularly convenient if you plan on making investment gifts on an annual basis. It can also be an excellent training tool as your child comes of age and wants to try his or her hand at actual investing.
With those provisions in mind, let’s move forward. What investments make the best gifts?
You can always give individual stocks as gifts; however, single shares can be expensive to purchase. Not only will you have the cost of the share, but you will likely also have to pay some sort of certificate fee for the provider to deliver the stock. In some cases, this can be more expensive than the cost of the share itself. In addition, if the recipient wants to sell the single share of stock at a later date, the process can be cumbersome and expensive.
This is an area for which you might want to consider setting up a custodial account, particularly if the value of the stocks that you want to gift is in excess of $1,000.
When giving stocks as gifts, you can make it more relevant to a child or teenager by making it a stock in a company that they can relate to. For example, you might want to get stock in a company that manufactures the computer that the child either has or wants to buy one day. If the child likes traveling to Walt Disney World, you might consider gifting stock in Disney. Use your imagination, and the gift can be especially meaningful.
Gifting Mutual Funds
Mutual funds, like index funds or ETFs, don’t have to be as personal as stocks. Keep things simple with shares of Vanguard’s Total (U.S.) Stock Market Index Fund (VGTSX) and/or Total International Stock Index Fund (VTSMX). In this way, the recipient is basically receiving the entirety of the market — not just a single investment, but a virtual portfolio of investments!
Like stocks, mutual funds will have to be purchased through a custodial account opened on behalf of the recipient or through a single share site. Even so, they may be more useful (just not as nostalgic) as single stocks.
Gifting 529 Contributions
Have a college-bound kid? Whether they are 18 months or 18 years old, help with college expenses can be a wonderful gift! Even better, most states allow a tax break for a certain amount of money contributed to a 529 in any given tax year.
If you are a grandparent, most states will allow you to contribute to the 529 plan opened by the parents as long as it is in your state. However, some states won’t allow you to take the tax deduction unless you are the owner of the account. You can always open your own account for the child and claim the full deduction. Check your state’s rules for more information.
Consider the child’s age when deciding which type of investments to include in the plan. For very young children, stocks and mutual funds may work well, since you’re dealing with a longer time horizon. But if the child is older and just a few years away from college, you might want to keep the investments on the more conservative side. If that’s the case, favor more predictable investments, even fixed-income investments or high-dividend-yielding stocks.
Gifting US Treasury Securities
If you’re over the age of 30, you probably received savings bonds as gifts at some point when you were growing up. Except under very limited circumstances, paper certificates are no longer issued by the Treasury. However, you can easily purchase US Treasury securities of various terms and denominations through the Treasury portal, Treasury Direct. You can purchase Treasury securities in denominations as low as $100.
The securities will be held with Treasury Direct, but you can set up a minor linked account that will hold the child’s securities. But do so in an account that is linked to yours. Information on minor linked accounts is provided on the website.
Gifting Traditional or Roth IRAs
This one comes as a surprise to most people, but you can gift an IRA — either traditional or Roth — to a minor. The only limitation is that you cannot exceed the child’s earned income. As long as your child has some sort of earned income, either from a part-time job or through employment by you if you’re self-employed, you can make a gift contribution up to the lower of the child’s earned income or the $5,500 IRA maximum contribution limit. So if your child had a part-time job and earned $3,000 during the year, you can gift up to $3,000 to fund a traditional or Roth IRA.
This can be one of the most valuable investment gifts of all, since it will grow throughout the child’s lifetime, the earnings are tax-deferred, and it will give your child a valuable head start in preparing for retirement.
Between the two, the Roth IRA will probably work best as a gift for a child. This is because the amount of the actual contribution can be withdrawn from the account without tax consequences at any time after it’s made. A young child may have various needs that would necessitate withdrawing funds early, and a Roth will add that flexibility.
So if there are any kids on your gift-giving list this holiday season, think seriously about passing up more traditional gifts like toys and gift cards, and consider instead giving an investment. It’s the kind of gift that can keep giving throughout a child’s life.
Is there a better gift than that?