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Parents spend a lot of money on their children while raising them -- on food, clothing, school, summer camps, braces, guitar lessons, lacrosse equipment, travel experiences, and much more. Parents also often simply give their children money, especially when they and their kids are older. Here are three smart ways to pass your wealth to your kids.
One smart way to pass your wealth on to your children is quite simple and direct: Give them gifts of money. The IRS lets you do so tax-free, though it does limit how much you can give. The limit is periodically increased, and for the past few years, and for 2016as well, the "annual exclusion for gifts" is $14,000.
If you're reasonably comfortably off, that $14,000 might not seem like much, and you might want to transfer a lot more than that to your kids. It's more powerful than you may think, though, because it applies to each recipient for each year, from each donor. So if you're married and you have three children, you and your spouse can each give up to $14,000 to each of your kids -- each year. That's $84,000 in a single year. Over just five years, you can transfer a whopping $420,000, tax-free. (Be sure to write separate checks for each $14,000 gift -- and tell your kids that they should cash or deposit the checks in the same year that they receive them.)
You may be able to give your children additional sums if they have tuition or medical bills. If you pay those bills -- by sending the money directly to the school or healthcare provider(s), not to your child -- those sums can be tax-free gifts, too.
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If you can help ensure that your child isn't burdened with student loan debt that will take decades to pay off, that's as good as passing your wealth on to them. That's why I think a Coverdell Education Savings Account (ESA) is a great vehicle to get that done.
As opposed to a 529 plan, a Coverdell allows you to make your own investment decisions. While that may not matter to a novice investor, it means that a more seasoned market participant can pounce on stock opportunities as they arise. Distributions from a Coverdell ESA are not taxed if they are spent on qualified education expenses.
Of course, there are downsides, such as the fact that you are only allowed to contribute $2,000 per year per child. Furthermore, if the money isn't used for qualifying education purposes, it can be taxed -- which defeats the purpose of the Coverdell in the first place. But given that contribution limits are so low, I think that's unlikely to be the case.
A great way to pass wealth to your kids is through a Roth IRA. From an estate-planning standpoint, a Roth IRA has some useful features. Specifically, you can continue to contribute to a Roth IRA for as long as you have earned income, and there are no required minimum distributions, no matter how old you are. Since you've already paid tax on the money you deposited into the Roth IRA, your heirs won't have to pay tax on distributions as long as the account has been open for at least five years, and inherited Roth IRAs are excluded from estate taxes, too.After you die, your kids will have a couple of options. They can choose to take the proceeds as a lump sum, 100% tax-free, or, even better, they can allow the money to continue to grow and compound for years.
Unlike your Roth IRA, inherited Roth IRAs do have required minimum distributions, beginning in the year after the original account owner dies. However, the amount that must be distributed each year is often relatively small and is calculated based on the IRS Single Life Expectancy Table.
For example, if your child is 40 years old when he or she has to start taking distributions from your Roth IRA, he or she can spread those distributions over a period of 43.6 years. This means that if the IRA has $1 million in it, the first required distribution will be just $22,935. The rest of the account is free to stay invested and grow tax-free, which is why a Roth IRA is a great way to provide your children with tax-free investments that can grow for the rest of their life.
The article 3 Smart Ways to Pass Your Wealth to Your Kids originally appeared on Fool.com.
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