Think About Incentives When Gifting To Children
Posted on April 13, 2007
I was involved in an interesting discussion recently on the golf course. I was playing with several business owners who are very successful and financially independent. Since they knew that I write a lot about wealth building and money management, I was invited to join their conversation about estate planning and the best way to transfer wealth to their heirs. What I found interesting was the widely varying philosophies within the group.
One man’s answer was to buy insurance to cover estate taxes. Another was to gift all he could during his lifetime to reduce the size of his estate. Still another felt he should sell most of his assets that weren’t liquid and get as much as possible into cash or cash equivalents so his heirs would not face having to sell assets under pressure to pay taxes. One even said he didn’t care what happened to his estate, that whatever his children inherited, it would be more than he had when he started.
The discussion went back and forth and everyone had their ideas, all of which were viable. It became apparent that each of us had different situations, so a technique that worked for one would not necessarily be the best for another. If you’ve ever sat down with an estate planner and reviewed your options, you know it can become quite confusing. I’m especially baffled by all the juggling required to minimize the effects of the tax code, which seems to drive everything. It reminds me of Philip K. Howard’s book The Death of Common Sense: How Law is Suffocating America (Random House 1994). What has happened to common sense in America?
The more I listened to the conversation, the more I realized that many of my golfing buddies were in danger of doing their children a real disservice. Although the current $1,000,000 lifetime applicable exclusion reduces the $2,500,000 Unified Credit that can be passed tax free upon death, many of these people are going to put their children in a position of receiving wealth without wisdom. All one has to do is look at what’s happening with some high profile trust fund babies to see that this can be a recipe for disaster.
Personally, I could relate to the one gentleman who said that whatever his children inherited it would be more than he had when he started. I started the same way, but unlike him, I have a hard time letting the government take a large chunk of what I’ve worked all my life to accumulate. At the same time, I don’t want my children just sitting around waiting on the old man to kick the bucket so they can live a life of leisure. I want them to learn that money doesn’t grow on trees; that wealth without sacrifice or risk is a myth, not a reality. As much as possible, I want to give them a hand up, not a handout.
Gifting to children who have yet to reach the age of maturity is one thing; gifting to ones who have completed their schooling, entered the workforce and are trying to establish their own families is something else. It’s gifting to these adult children or other adult heirs that I want to address. Currently there is an annual exclusion that allows gifts to individuals up to $12,000 each year without it reducing the previously mentioned Unified Credit. This exclusion is $24,000 for married couples because each can gift $12,000. If used properly, this annual exclusion can be a great tool to teach heirs about the sacrifice it took to build the wealth that will be passed to them, encourage them to work and allow them to experience the results of using discipline and restraint.
Here’s a tip! Whether you’re in a position to gift the full amount of the annual exclusion each year or just a few hundred dollars, there’s a common sense idea you might want to consider. Meet with your adult heirs and point out that during their life they will be faced with larger purchases like cars, boats, recreational vehicles, down payments on homes, etc., for which most people have to either save or go in debt to purchase. Offer to set up a savings account in their names that requires both your signature and theirs, to make withdrawals. Then, offer to match what they put into the account dollar for dollar up to the amount you of gift you want to give each year.
This method of gifting uses the annual exclusion to encourage heirs to work, earn and save and rewards them handsomely for doing so. Where else can they earn a 100% return on their savings in the first year? But, since half of the money going into the account will be yours, you need to have a string attached, which is the reason for the two signature requirement for withdrawals. To avoid providing funds that can spent frivolously and without restraint, there needs to be an understanding from the beginning that funds from this account may only be used to make large purchases that would otherwise have to be financed.
For example, instead of making a $500 per month payment for up to six years to pay for a car, the same vehicle could be purchased for cash in less than three years if the payments are made to this account and matched by you. Using the annual exclusion in this manner rewards heirs for developing the habits of savings and using financial restraint. It lets them see the benefits of earning interest instead of pay it. But even more importantly, it will help them develop the mindset of a wealth builder and teach them how to take better care of their inheritance when it comes.
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