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Investing Specialists

Feeling Generous? Do's and Don'ts for the Giving Season

When it comes to gifting, misconceptions abound.

My grandparents piled gift upon gift under the tree for us grandkids. But when it came to giving to one another, they ran out of steam. They wrote each other checks from their joint checking account.

That practice tickled my parents to no end. But the fact is, sometimes a gift of cash is the best gift, and not just because you're too tired to go out to the mall. Unless you live in a truly rarefied world, it's a good bet you have some loved ones who would get a much bigger boost from financial help than they would from accumulating more stuff.

If you're among the check-writers this holiday season, here are some do's and don'ts to keep in mind. (Note that this article focuses on giving to individuals, rather than charities; this article takes a closer look at charitable giving strategies.)

Do: Consider an investment gift.
If you're giving a financial gift with an eye toward helping your loved one down the line, one of the best ways to do that is to give an investment gift. Of course, the classic investment gift is a U.S. savings bond. But if you want to give something with a little more growth potential, you could give shares of stocks, mutual funds, or exchange-traded funds. While only a handful of mutual funds are available with very low minimums today, Charles Schwab offers some top-notch index mutual funds that let you in the door with just $100 initially. In addition, many investment providers now offer commission-free exchange-traded fund trades, meaning that small investors can get started with as little as the price of one ETF share. No matter what, read the fine print to ensure that account-maintenance fees, commissions, and other charges won't hobble your investment results; while investment-gift services make it easy to gift bite-size portions of stocks and mutual funds, for example, their dollar-based per-transaction fees can take a big bite out of your ultimate returns. 

If you're considering a gift of a security that you currently own, bear in mind that you'll also be transferring your cost basis, assuming you make that gift during your lifetime. For example, if you gift shares of a stock that you paid $25 for and it's now worth $100, the giftee would owe taxes on the $75 per share in appreciation if he or she sells. (Of course, if the giftee is currently in the 15% income tax bracket or below--meaning a 0% long-term capital gains rate applies--there wouldn't be any capital-gains taxes due upon the appreciation; if the gift-giver is in a higher tax bracket, such a gift can make good tax sense.) By contrast, the taxes due on securities that your loved ones inherit after your death will be based on the asset's price at the time of your death. That helps explain why people often transfer highly appreciated assets after death--via wills and beneficiary designations--rather than during their lifetimes.

Don't: Give investments without due consideration of the logistics.
If you're giving an investment gift to an adult, you can write a check or transfer funds directly to the financial institution of your choice; the recipient will have to fill out the application to set up the account, whether an IRA or a taxable brokerage account (or even a 529). If you're giving an investment gift to a child, you'll have to do so through a 529, UGMA/UTMA, or IRA (if the child has earned income). A 529 is best if you know the money will be tapped for college; not only will the money compound on a tax-free basis and skirt taxes upon withdrawal for qualified higher-education expenses, but you, the giver, may be able to receive a state tax break on a contribution to your home state's plan. Funding an IRA, meanwhile, can be an effective way to ensure that a young adult fully benefits from compounding for retirement, and the IRA wrapper offers tax benefits to boot. Note that the young person needs to have earned enough compensation (i.e., from work) in a given year to cover the amount of the IRA contribution that you're making on his or her behalf, though the contribution doesn't have to come directly from the young adult's own coffers. Finally, a UGMA/UTMA is an open-ended way to save for minor children; there are no strictures on how the money is ultimately used (which can be a drawback if you want the money to go toward college), and the assets can be invested in almost anything. Note that in contrast with IRA and 529 assets, UGMA/UTMA assets are a negative from the standpoint of financial aid calculations.

Do: Know that your gift won't typically lower your tax bill.
While you can earn a tax deduction on charitable contributions, contributions of either cash or property to individuals aren't generally tax-deductible. The one exception, as noted above, is a contribution to another person's 529 plan, which you can typically deduct on your tax return if you contribute to your home state's plan. (A common source of confusion is whether your child is required to go to school in that state to take advantage of the 529. The answer is no, unless you've contributed to a prepaid 529 plan.)

Don't: Gift primarily for estate tax reasons without checking to make sure there's a benefit.
When federal estate tax exclusion amounts were lower, many affluent individuals were urged to write checks regularly to their children and grandchildren, with an eye toward reducing their taxable estates. That practice can still make sense in some instances--for example, if a person has a very large pile of assets, lives in a state in which an estate tax that kicks in at levels more modest than the federal estate tax, or is trying to divest financial assets to improve Medicaid eligibility later on. Today, however, the federal estate tax exclusion amount is very high--more than $5 million per individual, and, thanks to the "portability" laws that were made permanent in 2012, more than $10 million for married couples. The net effect is that the estate tax just a tiny fraction of the U.S. population--in 2016, just 0.2% of all estates are expected to owe estate tax. While being generous can have multiple advantages, reducing your susceptibility to the estate tax shouldn't be a prime motivator in most cases, because it's likely it wouldn't affect you in the first place.

Do: Know the rules on gift taxes.
If you give $14,000 or less to any one individual in a single year, you fly completely under the radar; there are no reporting or tax requirements. Married couples can effectively give twice that amount with no tax or reporting requirements; for example, you and your spouse could give your daughter and son-in-law $56,000 in a single year. It's also worth noting that super-savers for college can steer $70,000 into a 529 plan in a single year, provided they make no further 529 contributions for the following four years. (Such an individual has effectively used up his or her gift-tax exclusion amount for the next five years ($14,000 times five).

Don't: Expect to Pay Any Gift Tax Unless You've Made Enormous Lifetime Gifts
Even though people are used to seeing "$14,000" and "gift tax" in the same sentence, that doesn't mean that gifts over $14,000 are automatically subject to gift tax. Rather, it means that that anyone giving in excess of $14,000 to any individual in a single year must file the Gift Tax Return form, and that excess amount counts against their lifetime exclusion amount. Only when those excess amounts (combined with the value of the individual's estate) exceed the lifetime exclusion amount--currently more than $5 million--does anyone actually owe taxes on those gifts. As you can surmise, the gift tax actually affects a very small subset of very wealthy individuals, and should definitely not be a barrier to giving for most people.