Getting tax advantages for child

[testtest]

I'm looking for advice regarding getting tax advantages and simultaneously help our child save for retirement. Taking advantage of a crazy-long time scale (our son is 2 years old) sounds great. Of course we plan on teaching him about the value of a dollar, the importance of sustainability and living within your means, etc., but I just love the kid so damn much, I want to set him of for a cushy deal. He might not know about it till I decide to tell him kind of thing.

We have a 529 to help him get through school, though we're being careful to not "over-fund" it. When he starts working as a teen I plan on making sure there's a Roth IRA fully funded for him. What can be done in the interim? What are the main advantages of UGMA/UTMA? Under what circumstances are they good or bad? If we have the cash, should I be considering things like gifting money to him below the threshold where he needs to pay tax on it? Is that even a thing?

For example, could I gift my 2 year old son 10k, then open an investment account in his name in put it all in a taxable index fund?

[secondcor521]

As an aside, sometimes...sometimes setting kids up with a cushy deal can result in a lack of drive and motivation.  Something to be aware of.

529's to fund the majority of the kid's education, as you agree with his other parent, is excellent.

Gifting directly to your kid, in moderation ($ for birthday, holidays) is good.

Gifting larger amounts...well, I'd wait until the kid is older before doing that.  Unless you're extraordinarily well-off (and you may be), you'll have time and bandwidth to do that later when the picture and trajectory of their life is more clear.

UGMA/UTMAs are not that appealing to me.  They don't really get you much more than a regular taxable account.

Yes, you could gift your 2-year-old son $10K and put it in a taxable account.  If you're 100% sure that you're not going to regret that later if he becomes a lazy drug addict and high school dropout, then go ahead, it's perfectly legal.  In fact, each parent could gift the kid up to $14K per year (I think that's the limit, it may have gone up due to inflation), so you could move $28K to him every year if you wanted to.

[GizmoTX]

I would never do UGMA/UTMA, which makes the account completely accessible to the child at age 18. We have a nephew who is doing absolutely nothing at age 25 while living off his UGMA money from the grandparents.

Beware of the kiddie tax, which taxes unearned income from your child's account, currently at $2100+.

We set up an irrevocable trust when DS was a year old & gifted to it each year. The trust pays any income tax, avoiding the kiddie tax at our income level. While the trust was intended for college, it was set up to fund any support or welfare issue as well, for maximum flexibility. DS is entitled but not required to receive 50% of any residual funds upon his 4-year college graduation, then another 50% of residual on his 30th birthday, & the remainder on his 35th birthday. As trustee, we retain control how the funds were/are invested. As it turned out, DS received 2 major merit scholarships & we cash-flowed the remainder of his undergrad expenses. He has chosen not to cash out at the present time but to let it keep accumulating while he works full time as a new engineer. We started funding a Roth IRA for him when he began working summers in high school by matching his earnings, then he fully funded it from college summer internships.

[ender]

1. Save a lot of money yourself.
2. Make sure you have a will/trust setup that only gives out money at age <whatever age is reasonable to you>
3. Done

You could do what Gizmo suggested too:

We set up an irrevocable trust when DS was a year old & gifted to it each year. The trust pays any income tax, avoiding the kiddie tax at our income level. While the trust was intended for college, it was set up to fund any support or welfare issue as well, for maximum flexibility. DS is entitled but not required to receive 50% of any residual funds upon his 4-year college graduation, then another 50% of residual on his 30th birthday, & the remainder on his 35th birthday. As trustee, we retain control how the funds were/are invested. As it turned out, DS received 2 major merit scholarships & we cash-flowed the remainder of his undergrad expenses. He has chosen not to cash out at the present time but to let it keep accumulating while he works full time as a new engineer. We started funding a Roth IRA for him when he began working summers in high school by matching his earnings, then he fully funded it from college summer internships.

[secondcor521]

The trust pays any income tax, avoiding the kiddie tax at our income level.

I thought trust tax rates were way more aggressive / progressive than individual tax brackets, so I am curious how (it seems) you think this is saving you on taxes?

http://www.legalees.com/trust-tax-rates/

Or maybe you distribute all the income to him as DNI?

I'm just learning about trusts now...

[GizmoTX]

The trust tax brackets are similar to an individual's, only there's no standard or personal deduction, just a $100 exemption. It still saved money because it was never taxed at our upper bracket. We also chose very tax friendly investments, i.e. no volatility. Because the trust files a return each year, when DS does opt for a distribution, it will be tax free to him.

[secondcor521]

The trust tax brackets are similar to an individual's, only there's no standard or personal deduction, just a $100 exemption. It still saved money because it was never taxed at our upper bracket. We also chose very tax friendly investments, i.e. no volatility. Because the trust files a return each year, when DS does opt for a distribution, it will be tax free to him.

OK, but I still don't understand your first two sentences.  I'm assuming you're filing MFJ.  For 2017, the 28% bracket for MFJ starts at $91,901 but for trusts it starts at $6,001 and the 33% bracket for trusts starts at $9,151.  From what I can see the trust brackets are very compressed; that is, they're structured like individual tax brackets but you get into the higher brackets faster.

So if you're - as a random example - making $150K and the trust makes $10K, your marginal rate is 28% and the trust's marginal rate is 33%.  If you had kept that $10K of trust income on your books instead of the trust's, you'd save 5% on your marginal rate - only $500 I guess, but still...  (I also don't know how it would have worked had that $10K been distributed to your son - if he avoided kiddie tax rules that way, that might have saved you some taxes...?)

I can see there are many legitimate reasons to set up a trust, but I don't understand how it saved you on income taxes.

2017 tax rates taken from here:  https://www.edwardjones.com/images/OPR-9806A-A.pdf

[seattlecyclone]

What are the main advantages of UGMA/UTMA? Under what circumstances are they good or bad?

An UTMA account is basically a taxable brokerage account in your kid's name. You have control over investments and distributions until an age specified by your state (usually 18 or 21). After that age, all legal control over the account is transferred to the kid, whether you think that's a good idea at the time or not. Before that age, you're allowed to withdraw the money for the kid's benefit, but are not supposed to spend the money on anything that you as a parent are required to purchase from your own funds (food, housing, clothing, medical care, etc.). The theory is that once the money hits the UTMA account it is no longer yours; it is an irrevocable gift to your child. You can't make a minor child pay for their own room and board, so taking money from the UTMA to pay for that is therefore out of bounds.

As the money belongs to the kid, a large UTMA balance upon entering college can be very detrimental to the kid's chances of qualifying for need-based financial aid. Students' assets tend to be weighted much higher in financial aid formulas than parental assets (a 529 generally counts as a parental asset).

Where the UTMA can be useful is that a kid's investment income below the kiddie tax threshold ($2,100) is taxed at the kid's own rate, often 0%. Suppose you transfer some appreciated stock to the UTMA and realize $2,100 of capital gains within that account instead of your own. The kid will be paying 0% federal tax on that, while you might have paid 15% or more. Seems like a win, as long as you can keep the overall balance low enough that you don't run into some of the downsides (the prospect of handing over a bunch of legally unrestricted money to an 18-21-year-old, lower financial aid in college, etc.).

How to keep the balance down after making a gift? I think basically any discretionary expense for the kid would be allowed here. Summer camps, computer equipment, plane tickets to visit out-of-state relatives, music lessons, and sports leagues all seem like defensible expenditures: something for the kid's benefit that a parent isn't legally required to provide. I haven't yet opened an UTMA for my two-year-old, but am considering doing so this year now that I have some taxable assets that have appreciated a bit. The prospect of up to $2,100 in tax-free capital gains seems worth a little bit of hassle in setting up the account.

[spacecadet610]

What are the main advantages of UGMA/UTMA? Under what circumstances are they good or bad?

An UTMA account is basically a taxable brokerage account in your kid's name. You have control over investments and distributions until an age specified by your state (usually 18 or 21). After that age, all legal control over the account is transferred to the kid, whether you think that's a good idea at the time or not. Before that age, you're allowed to withdraw the money for the kid's benefit, but are not supposed to spend the money on anything that you as a parent are required to purchase from your own funds (food, housing, clothing, medical care, etc.). The theory is that once the money hits the UTMA account it is no longer yours; it is an irrevocable gift to your child. You can't make a minor child pay for their own room and board, so taking money from the UTMA to pay for that is therefore out of bounds.

As the money belongs to the kid, a large UTMA balance upon entering college can be very detrimental to the kid's chances of qualifying for need-based financial aid. Students' assets tend to be weighted much higher in financial aid formulas than parental assets (a 529 generally counts as a parental asset).

Where the UTMA can be useful is that a kid's investment income below the kiddie tax threshold ($2,100) is taxed at the kid's own rate, often 0%. Suppose you transfer some appreciated stock to the UTMA and realize $2,100 of capital gains within that account instead of your own. The kid will be paying 0% federal tax on that, while you might have paid 15% or more. Seems like a win, as long as you can keep the overall balance low enough that you don't run into some of the downsides (the prospect of handing over a bunch of legally unrestricted money to an 18-21-year-old, lower financial aid in college, etc.).

How to keep the balance down after making a gift? I think basically any discretionary expense for the kid would be allowed here. Summer camps, computer equipment, plane tickets to visit out-of-state relatives, music lessons, and sports leagues all seem like defensible expenditures: something for the kid's benefit that a parent isn't legally required to provide. I haven't yet opened an UTMA for my two-year-old, but am considering doing so this year now that I have some taxable assets that have appreciated a bit. The prospect of up to $2,100 in tax-free capital gains seems worth a little bit of hassle in setting up the account.

I just did this with my 6 month old. Put $15000 of highly appreciated stock into my son's UTMA account.

Plan to harvest gains tax free.

Plan to pay off his expenses and deplete UTMA by college age.

There is debate on whether the UTMA expenses must be ONLY expenses that parents must provide: http://fairmark.com/kids-college/utma/what-expenditures-are-proper/

If one wants to be aggressive, one can pay all child expenses using this fund.