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  • Writer's pictureRyan A. Dunn, CFP®

Gifting When Your Adult Children Aren’t Fully Grown Up

Elderly father lends money to his adult son. He helps his child deal with financial problems.
Key Takeaways
  •  Instead of giving cash to adult children, consider legacy planning to help them fund retirement, college savings, or healthcare.

  • The tax-smart gifting techniques below can reduce your estate while helping adult kids become financially independent.

  • Before making a gift, be sure your child is crystal clear about how the money should be used (and not used).

 

Parents are supporting their adult children for far longer than in previous generations. Whether that be paying for cell phone bills, auto insurance, or a place to live. This, invariably, leads to tough conversations about cutting the financial cord. But there may be better, and less emotionally charged, ways for parents to help their adult children financially while still moving them on the road to financial independence. At Novi Wealth Partners, we help clients navigate these difficult conversations by providing them with empathetic guidance and actionable strategies that foster open communication and mutual understanding between parents and adult children.


Parents want what’s best for their children, but this looks different for every family. For some, this might include covering educational expenses. For others, it might include more substantial gifts. That said, cash gifts aren’t always the best option for every situation. If a child hasn’t learned to be responsible with money, even into adulthood, there are other ways to help them prosper without continually putting cash into their pockets. We like to call this legacy planning and here are three good ways to get started on this path:


  1. Contribute to a Roth IRA while a child has recently entered the workforce.

  2. Pay for an adult child’s health insurance (if they don’t have it through their employer). 

  3. Overfund a 529 to create a pool of money to cover tuition for grandchildren.


Let’s take them one at a time:

 

1. Contribute to a Roth IRA while a child has recently entered the workforce.

Business concept meaning IRA Roth For Child with phrase on the page.

It takes a while for many young adults to get on their feet even after landing their first job. Apartments are expensive today. The child may need to buy a car to get to and from work and student loans may need to be paid off. The bottom line, it’s hard for young adults to save money in general, let alone for retirement. Parents may not want to start giving their new grads money outright because they worry it could be wasted on wants rather than needs. Instead, they can open a Roth IRA on the child’s behalf.


This allows them to contribute (i.e., “gift”) up to $7,000 annually into the account for the first several years of their adult child’s working years. That money will continue to grow and compound (tax-free) for the next 40 years or so, because the child can’t access the money (without penalty) until they reach retirement age. Let’s say the parents gifted $7,000 a year into a young adult’s Roth IRA between the ages of 22 and 26. Assuming a 7% annual rate of return, those $35,000 of gifts/contributions over the first five years of the child’s working life would grow to over $600,000 (tax-free) by the time the adult child was in their mid-60s.


Even better, since the annual gift exclusion is now up to $18,000 a year per spouse, per child ($36,000 per couple), the parents can gift an additional $29,000 to each child for their 529 plan, their health plan, or for other purposes.


2. Pay for an adult child’s health insurance (if they don’t have it through their employer). 

Let's say an adult child just finished school and is not working full-time or is simply earning a low-income entry-level salary for an employer that doesn’t provide healthcare. Parents can gift shares of appreciated stock to the child and have the child sell the stock at their presumed 0% capital gains rather than at the parents’ rate of 15% to 20% (federal) plus state capital gains. The child would then be instructed to use the proceeds specifically to pay for health coverage, by purchasing it on the health care exchange. When considering the standard deduction, if the child had no employment income, the parents could gift appreciated stock and have the child realize up to $61,750 in capital gains entirely tax-free. Of course, we need to consider the gift tax limits of $36,000 total ($18,000 per parent).


This is when parents (sometimes joined by us) have a conversation with the child: “Hey, we are giving you this money to pay for your health insurance. It's in your best interest not to spend it on frivolous things.” Further, we can set up automatic payments to the insurer from the adult child’s account to ensure those funds are being used appropriately.


wooden blocks speling out 529 on stack of money

3. Overfund a 529 plan to create a pool of money to cover tuition for grandchildren. 

Often, we see parents want to help their young adult children (who aren’t completely financially responsible) save for big-picture life goals, say college tuition for the grandchildren. Rather than giving the money directly to the young adult children – where they can’t be sure what will happen to the money – the parents can over-contribute to a 529 plan on behalf of the grandchildren. That way, adult children don’t need to worry about saving for their kids’ tuition. And if there’s still money left over in the account because the grandchildren received scholarships, went to less expensive schools, or simply didn’t attend college, then that money can be rolled over into a 529 for the next generation. There are no gift or estate tax implications when doing a 529 rollover to new beneficiaries. Even better, that money can grow in the account tax-free for the next say, 20 to 25 years, which builds a very substantial legacy for the family.

 

While helping their children financially is important for some clients, we don’t want them to jeopardize their financial plan by giving too much wealth away or by giving it away in a non-efficient manner. According to a recent Credit Karma survey, more than one-fourth of parents who are helping their children financially said it caused them to postpone retirement. More than half had to cut back on living expenses and about a third took on debt. Most disturbing, the study found that three in five parents (59%) who financially support their adult children say it causes them mental stress. It is important to understand your whole financial picture first to determine what is possible when giving to your loved ones.


Conclusion

Not every family’s situation is the same. And even among couples, not every parent has the same goals and aspirations for their children. If you or someone close to you has questions about tax-efficient legacy planning or about gifting strategies for adult children, please don’t hesitate to reach out. We’ve helped many clients like you in similar situations.

 

RYAN A. DUNN, CFP®, is a Wealth Manager at Novi Wealth 

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