When planning to pass down wealth to the next generation, there are several strategies that may be appropriate. One of the most common strategies our clients use to transfer assets to their children is a consistent program of annual gifts. The Internal Revenue Code grants you the right to make a gift to an unlimited number of people each calendar year without incurring gift tax or using your applicable exclusion. That amount, called the annual exclusion, is $17,000 in 2023 ($34,000 for married couples), and is adjusted periodically for inflation.

A parent, grandparent, or friend can make monetary gifts directly to a minor or to a custodian for the minor’s benefit. However, giving the gift outright is often less efficient. Instead, a 2503(c) trust, trust with Crummey withdrawal rights, UGMA/UTMA account, or Section 529 education savings plan may be an appropriate vehicle for your goals.

2503(c) trust

One option for those looking to gift money to next-generation family members is to create a 2503(c) trust for the benefit of the minor and place the gift in the trust. To qualify for the annual gift tax exclusion, the trust must state that any income previously not distributed to the child, or spent for his or her benefit, will be distributed or offered to the child when he or she reaches age 21. For example, a 2503(c) trust can be an excellent vehicle option for a parent or grandparent to build a child’s college fund.

If the beneficiary agrees, the assets can also remain in trust after the beneficiary turns 21. However, it is important to note that to qualify the trust under 2503(c), all of the trust’s property must be offered to the child when he or she reaches age 21, whether or not the child is mature enough to receive it.

Crummey trust

The Crummey trust is named for Clifford Crummey, the first successful taxpayer to use this technique. Crummey trusts offer an alternative to custodial accounts, in which the child must be offered the trust’s property upon the age of majority. Instead, Crummey trust beneficiaries have a set window of time during which they can withdraw the assets. For example, they may have a 30- or 60-day window to take immediate control of the gift.

The control offered only applies to the current gift – typically an amount no greater than the annual exclusion amount – not the entire trust. It is important to note that beneficiaries must be notified of their right to withdraw the gift, and therefore will be made aware of the trust.

UGMA/UTMA

The Uniform Gift to Minors Act (UGMA), and by extension the Uniform Transfers to Minors Act (UTMA), allows minors to receive gifts in an account managed by an appointed custodian until they become of legal age in the state in which they live. UGMA accounts can hold any financial assets, while gifts to an UTMA account can include money, patents, royalties, real estate, and fine art.

UGMA/UTMA accounts are easy to establish and can provide a tax-efficient way to make larger gifts to a minor without setting up a trust. Once the beneficiary reaches age of majority in his or her state, he or she takes control of the account. This can sometimes be a very large amount to receive at once, particularly if the assets have grown over time. For custodians who want more oversight in the distribution of funds, it may be worth setting up a trust or considering other tax-efficient ways to gift to minors.

Section 529 education savings plan

Section 529 education savings plans provide a tax-advantageous way to help pay for a child’s education.  The earnings on the assets in 529 plans grow tax-deferred, and withdrawals are tax-free if used for qualified educational expenses, which are broadly defined to include tuition, fees, room and board, and any other related costs. The earnings on any withdrawals used for nonqualified educational expenses are subject to income tax and a 10% penalty.

529 plans can pay for both K-12 and college education. After establishing an account in one of these plans and making an initial contribution, the donor becomes the owner of the account and can designate the initial beneficiary of the account. The owner may transfer the 529 plan once per year to a different beneficiary, provided the new beneficiary is another family member (with certain restrictions on who qualifies as a relative).

Beginning in 2024, any unused money remaining in a 529 plan account after a beneficiary has completed his or her education can be rolled directly into a Roth IRA account.

Choosing the right strategy

There are many options for transferring wealth to the next generation beyond cash gifts. 2503(c) trusts, trusts with Crummey withdrawal rights, UGMA/UTMA accounts, and 529 plans are some of the most common and tax-efficient strategies available. Each has benefits and considerations based on a family’s specific situation, goals, and objectives.

If you are interested in discussing your options further, please reach out to the BBH Next Generation team.