I am not here to see you, son, I’m here to see your kids! Anyone in my family knows my mother does not play “Minnesota nice;” she says it how it is. Over Thanksgiving, and really during any family gathering, my mother makes it a point to prioritize time with her beautiful, athletic, and well-adjusted grandchildren. My siblings and I don’t need to be present for my mother to enjoy Thanksgiving.
Perhaps by reason of seeing their own grandchildren over the Thanksgiving holiday, it seems like I have many discussions this time of year with my clients about how to best provide for their grandchildren through their estate plan. In this month’s update, I provide (i) some of the reasons for why clients decide to provide directly for grandchildren; (ii) the tax rules relevant to making lifetime gifts for grandchildren, and (iii) emphasize the importance of coordinating an estate plan with lifetime gifts.
Why Should Clients Provide for Grandchildren?
Clients might provide for grandchildren to achieve the following objectives:
- To Pay for Specific Expenses. Rather than leaving assets to be for any number of unspecified purposes, many of our clients love the idea of leaving assets to meet certain needs (e.g., education). Many clients make arrangements for the educational expenses of grandchildren, either directly during lifetime or through the use of a College Education Savings Plan (“529 Plan”).
- To Minimize Risk of Loss or Misuse of Assets. If the clients are concerned about the possible misuse by their adult children of inherited assets, or if the child is likely to face a substantial risk of financial loss, such as through a divorce, then creating a plan to distribute assets for the benefit of the child’s children (i.e., the clients’ grandchildren), clients can have some level of assurance about the proper use of the inherited assets. The plan can take the form of gifts directly to grandchildren or, more likely, to 529 plans or to trusts for their benefit.
- Skipping Children to Minimize Income Taxes or Estate Taxes to Children. Alternatively, a client may decide to “skip” one or more children not because of any bad event occurring in the lives of their children, but because the opposite is true; that is, a child is so successful in his or her own right that transferring assets would only add to the child’s ongoing income tax burden during lifetime and impose additional estate taxes at death. his or her estate tax burden (at death).
- To Manage Equalities of Family Wealth. While most of our clients believe that assets should be divided equally at the “first” generational level of their children, some of our clients believe it important to provide equally at the “second” generational level of their grandchildren.
What are the Tax Implications of Providing for Grandchildren?
The following tax rules are important to those families considering lifetime gifts to benefit grandchildren:
- Annual Exclusion Gifts. An individual may gift up to $15,000 annually to any family member (e.g., child or grandchild) without having the value of that gift count against his or her so-called “unified credit” from federal estate and gift taxes. For my Minnesota clients who have assets in excess of the Minnesota estate tax exemption ($3.0 million for 2020 and beyond), making annual exclusion gifts to grandchildren avoids the implication of the “3 Year Rule” that would otherwise subject gifted assets to Minnesota estate taxes if clients die within three years of making the gift.
- 529 Accounts. A gift made to a 529 Plan account for the benefit of a grandchild qualifies as an annual exclusion gift. Grandparents can “superfund” a grandchild’s 529 Plan account by transferring cash to the 529 Plan having a value of up to five times their annual exclusion gift amount. Since the 2019 annual exclusion gift amount is $15,000, grandparents can currently gift up to $75,000 to a grandchild’s 529 account in one calendar year without using unified credit.
- Tuition Payments and Health Care Costs. A check written directly to an educational institution for tuition does not count against a client’s annual exclusion gift amount. Likewise, if a grandchild has incurred significant medical expenses, a grandparent may write a check directly to the care provider, and this gift does not count against the client’s annual exclusion gift amount.
- Lifetime Unified Credit. One of the most commonly misunderstood issues for clients is the implication of making gifts above the annual exclusion gift amount. If clients give more than $15,000 in 2019 to any one family member, the client will not likely pay any gift tax; rather, the client will need to file a gift tax return to report that the amount of the gift in excess of the annual exclusion gift amount utilizes some of his or her unified credit. Since the current federal unified credit is $11.18 million, most clients are not in danger of exhausting their unified credit during lifetime and paying gift taxes.
How Do You Coordinate Lifetime Gifts With an Estate Plan?
It is critically important that a client’s lifetime gifting strategy be coordinated with the provisions of his or her Will or Revocable Trust. I often recommend using “make up” provisions for the benefit of younger grandchildren who, as of the time of the grandparent’s death, may not have had the same opportunity to receive the same amount of gifts. In such cases, the younger grandchildren can be “equalized” following the client’s death for certain lifetime gifts that were made to the older grandchildren during the client’s lifetime.