Over time, your estate plans will probably change due to marriages, divorces, births, and deaths. Many people leave their accounts and property to their children, assuming their wealth will eventually pass on to the next generation, but in some cases, transferring property and accounts directly to their grandchildren makes more sense.

Gifting Money During Your Lifetime

Gifting money to your children and grandchildren during your lifetime reduces the size of your taxable estate. As long as you stay under the federal annual and lifetime gift tax limits, you can transfer wealth to your grandchildren without incurring a penalty or tax.

The federal government defines a gift as the transfer of any property, income on property, or money to another person without expecting something of equal value in return.

The 2024 annual gift tax exclusion is $18,000. If you are married, each of you can gift $18,000 to each of your grandchildren each year. If you exceed this limit, you are required to file a gift tax return (IRS Form 709) with the Internal Revenue Service (IRS) to report it.

In addition to the annual gift tax exclusion, there is a lifetime gift tax exclusion of $13.61 million. Each annual gift is deducted from your lifetime gift exclusion. The current tax reform law is temporary and will expire at the end of 2025. In 2026, the lifetime gift tax exclusion is expected to return to its pre-2018 level of $5 million, adjusted for inflation.

Outright gifts are an excellent choice to reduce taxes, but only if your grandchildren have reached adulthood and will responsibly use your gift.

Naming Beneficiaries in a Will

Another option is to name your grandchildren as beneficiaries in your will. Similar to gifting during your lifetime, this can be a good option if your grandchildren have reached adulthood and are financially responsible and prudent when using financial gifts.

If your grandchildren are minors, the executor of your estate may need to create custodial accounts for minor children to hold their gift until they reach the age of majority (18 or 21, depending on the state). Contributions to custodial accounts are irrevocable. The funds in the account belong to the minor. A parent cannot spend a child’s inheritance from their grandparents. Incomes above a certain level can trigger a lower tax rate, known as the “kiddie tax.”

The Uniform Transfers to Minors Act (UTMA) allows money and securities to be transferred to minors without the aid of a guardian or trustee. The gift giver or an appointed custodian will manage the minor’s account until they reach the age of majority. The custodian has a fiduciary obligation to manage the minor’s account.

According to the UTMA, minors can receive gifts and save money without any tax consequences until they reach the age of majority.  Since the account is owned by the minor and their social security number is used to report taxes, the account may impact their eligibility for financial aid and scholarships.

Creating a Trust

A trust is an estate planning tool that provides flexibility and control when transferring your wealth to your children and grandchildren. You can specify in your trust documents how and when your money and accounts are distributed to your beneficiaries. For example, if you are concerned about your grandchildren’s ability to handle money appropriately, you can add spendthrift provisions to your trust document to restrict access and protect the trust from potential predatory creditors.

There are several different types of trusts, each with its own advantages and disadvantages. Here is one example to consider and discuss with your estate planning attorney.

Health and Education Exclusion Trusts

A health and education exclusion trust (HEET) takes advantage of certain tax code provisions that exclude money used directly for health and education from the lifetime gift limit. The trust can directly pay medical and tuition expenses for beneficiaries who are two or more generations away from the trust creator.

A HEET trust must also have a charity as a beneficiary, in addition to grandchildren or further generations of beneficiaries. As long as the trust makes meaningful and generous donations to its charitable beneficiary, the distributions to the other beneficiaries can be made without incurring a generation-skipping tax (GST).

The GST applies to grandchildren, succeeding generations, or any nonrelative who is at least 37 ½ years younger than the person making the gift.

Creating trusts to transfer wealth and minimize estate taxes is complicated. If your estate is valued at more than the current lifetime gift exclusion, the GST is a significant tax that must be considered when transferring wealth to your grandchildren.

When creating an estate plan that involves making generous gifts to your grandchildren, consider involving your children in the conversation. Depending on their parenting philosophy, they may have strong opinions on whether they would appreciate a large financial gift for their children (your grandchildren).

Parents may prefer that their children become financially independent through hard work and sacrifice. Large financial gifts may also disqualify grandchildren from receiving scholarships and financial aid. Talk to your children about your plans for making financial gifts to your grandchildren to see how you can best support them throughout their lifetime.

If you have questions about transferring wealth across multiple generations or want to learn about how to protect your assets and property with a comprehensive set of estate planning tools, contact us.