Setting Up Brokerage Accounts As Gifts - Advice Needed

[Zona]

I have a small $5k inheritance from a relative's life insurance. DH and I are comfortable and do not need this money. We have no kids, but I have four nieces/nephews (ages 3-10) that I want to somehow benefit with this money at a future date. I received memorable financial gifts in my 20's from older relatives and appreciated the thoughtfulness as well as the financial lessons about investing long-term.

Each of my nieces/nephews already has a 529 plan that I contribute to, but I want more flexibility as to the timing and type of gift this will be. What I want to do with this $5k is to set up four taxable "Auntie Investment Accounts" that are in my name but TOD to each kid. I plan to seed the money equally among them ($1250 each) and invest in a simple ETF in each with dividend reinvestment turned on. Maybe add $100 each year at birthday or Christmas time. At some point, as each kid gets to the age where they start to "get it", I'd like to reveal that they (or rather, I) have this investment account and demonstrate how small amounts can grow over time via compounding. I want to be able to gift them the whole account in-kind sometime in their early to mid 20's (assuming that college/tradeschool is already covered) when they are ready to start their financial life. I am hoping to start a discussion on this thread to address a few points that require decisions. Has anyone else done this before or considered doing it? Here are a few notes/questions:

1. Taxes - I'm thinking any dividends will show up as taxable to me and DH for the years that we own the accounts. That's okay.

2. Tax Loss Harvesting - I want to invest in a broad index or ETF that's simple to understand but that won't interfere with my own TLH in our taxable accounts (we hold SPY and VOO in our taxable accts). There is a mutual fund SWPPX that is dollar-based so that I could invest all the money with no idle cash, but I worry that is too similar to SPY. To avoid any wash sales in taxable accounts, maybe hold something similar but substantially different for the kids, like QQQ or QQQM? Or maybe VTI or another SPY-type but not exactly SPY that I could put them in? Any ticker suggestions for something like this?

3. Cost Basis - if I gift them the account in-kind they will retain my basis, and will have to pay cap gain taxes when the shares are sold. I'm of two minds here - I don't want to give them a tax burden, but also I think maybe they need to "own" the tax basis to understand how capital gains works. Would you have been annoyed in your 20s at getting a gift like this with a tax burden?

4. Gifting - I am guessing that these accounts will probably not exceed the gift tax exclusion amount by the time I'm ready to gift them. If the market works out over time, at most they'll each have maybe a small-ish account of $10-20k or so. Current gift tax exemption is $18k and I'm sure will be larger in 15-20 years. I was planning to just set up the account in my name only so that they transfer TOD immediately if something were to happen to me. But if I'm still alive when I'm ready to give the account and the value exceeds the gift tax exemption, could I add my spouse to the account last-minute so that we both give the gift? Or is that cheating?

5. Spendthrifts/Fairness - in a perfect world, all four kids will be starting successful careers and open to learning about money when I give these gifts. But life isn't perfect. If one or more turns out to be a spendthrift or has an addiction problem or something, what would you advise? By keeping the accounts in my name until I'm ready to gift it, I get flexibility to change my mind and gift the money in a different way later (such as putting it towards rehab or something else more appropriately helpful). How would you address this potential scenario?

Please share any advice or thoughts you have about setting this up. I know several of you are gifting generously to relatives and nieces/nephews and would love to hear how you do it and if my approach makes sense or has unanticipated pitfalls.

 

[mrfeh]

I have no experience with what you are trying to do, but I ran a search on bogleheads. Here's a wiki page and a couple threads that might be of use:

Uniform Gift to Minors Act - Bogleheads

www.bogleheads.org

Gifts to a minor: UTMA, 529, or parent held brokerage - Bogleheads.org

Custodial account for child up to age 25 - Bogleheads.org

 

[Zona]

Thanks for those links, mrfeh. The 2nd one links to a question about a similar setup to the one I'm proposing, although the comments all seem more focused on 529s and UTMAs rather than a brokerage account owned by the giver and eventually gifted in-kind to the recipient later in life. It is interesting - I guess I'm really just trying to "earmark" these funds for eventual gifting to these specific people. I don't want to just mingle them in with my own funds in my own brokerage because I want to actually track the growth over time to give them the initial amount + earnings. And I want to be able to give them a binder with annual statements going back to inception to demonstrate how the small initial investment grew over the years. But at the same time I don't really want the restrictions imposed on a 529 or a UTMA account.

Maybe most people who are gifting relatives up to the annual gift exclusion just give some amount out of their own funds that was not specifically set aside for that purpose?

 

[youbet]

What are the restrictions imposed to a UTMA account that you are concerned about?

I'm not very familiar with TOD accounts but I am curious as to what happens if you die shortly after establishing the accounts and the kids are still very young (ages 3 - 10).

 

[Zona]

What are the restrictions imposed to a UTMA account that you are concerned about?

Good question. When researching the UTMA, I came across this on Fidelity "Between the age of 18 and 25 (it varies by state) legal control of the account must be turned over to the child, who can then use the money for any purpose they choose."

So I looked it up and in my state, the ages are 18 for UGMA and 21 for UTMA. That is too soon for my purposes. I think back to myself and my siblings at those ages and I am so glad that my grandmother and aunts waited to give me any legacy gifts until I was older (25+) and a bit wiser enough to appreciate them and actually invest them for growth instead of just spending the cash immediately. And also if I encounter scenario 5 in my original post, I don't want to have to give it to the child for "any purpose they choose". If any of them end up having addiction issues, that would actually be problematic.

 

[youbet]

I did find this, from City National Bank, about TOD's:

“But it gets more complicated if you name a minor. Then you would need a court-appointed supervisor to manage the assets until the child turns 18." After the account owner dies, the beneficiary must provide a death certificate or some other document as proof of death."

 

[Zona]

Hm, okay I had not thought of that. That's helpful -- I don't want to cause legal/probate headaches for anyone. DH & I have recently had to be executors for our parents and found that the TOD accounts were so much easier to distribute (beneficiary simply shows up with the death cert and their ID). So that's why I thought of TOD.

If I set these brokerage accounts up in my name at Schwab for example, they will each have an individual beneficiary and there is a place to name a contingent beneficiary. Perhaps while the kids are <18 I name my sibling (their parent) as primary 100% beneficiary and the child as contingent. Then when the child turns 18 I change the primary beneficiary to the kid. Then I can hold onto the account until their mid-20's and transfer ownership in-kind at that time.

 

[mrfeh]

Kind of sounds like what you really want is a trust.

I wonder if a really simple trust could be done without a lawyer...

 

[Zona]

Kind of sounds like what you really want is a trust.

Dollar amounts are so small, I was hoping that a beneficiary designation or TOD would be sufficient. I'm in good health and expecting to be the one transferring these accounts to my "niblings" when they are ready for them. I don't know that putting these accounts in four individual trusts would be worth the effort or complexity.

 

[marko]

Dollar amounts are so small, I was hoping that a beneficiary designation or TOD would be sufficient. I'm in good health and expecting to be the one transferring these accounts to my "niblings" when they are ready for them. I don't know that putting these accounts in four individual trusts would be worth the effort or complexity.

If I'm reading correctly, you're talking about $1250+ per child. To me, it seems like a lot of work for a relatively small amount of money.

Why not set aside the cash and reserve it for small incidentals that the kids need along the way; school clothes and supplies, music lessons, summer camp and such? Tell them that the money is coming from a "small fund" that has their name on it. Taxes on gains from $5k should be negligible.

You already have a 529 which, when the time comes is an opportunity to discuss finances.

 

[Zona]

You already have a 529 which, when the time comes is an opportunity to discuss finances.

The parents set up the 529s but I don't have visibility to what those accounts are invested in. Their parents sent out "contribution links" to family when they set them up, and we put money in at Christmas time each year. My sisters have mentioned that I am the only one of the extended family who actually contributes to those accounts.

I do intend to give normal gifts throughout childhood, like you mentioned. I'm sure my aunts and grandparents did the same for me as I grew up, but I was too young to remember specifics or, honestly, to appreciate those gifts at that time. But when I bought my first house, my aunt presented me with a paper EE bond that my grandmother had set up twenty years earlier. The amount was small but substantial (to me) at the time. The fact that my grandmother had the presence of mind to consider such a gift, hold on to it, and then ask my aunt to continue to safeguard it for a "special occasion when I was ready for it" after my grandma passed -- that was very meaningful and memorable. My aunt sat me down, explained how much was initially invested, how it had doubled after 20 years, and how it would continue to earn interest. It was a good lesson about compounding. I am hoping to do something similar for my nieces/nephews. I learned so much more financially from my aunt than I ever did from my parents.

 

[Unpaintedhuffhines]

There is no $18K/year limit that you refer to (assuming you are in the US). Above $18K you just have to report it - no taxes are due upon transfer (for the gifter or the giftee). The current lifetime limit is $13M (per person), above which the person giving the money has to pay the tax.

On the cost basis, if you give stock upon death, I believe the current law says the beneficiary gets a stepped-up basis. However, gifting stock now is a good way for them to learn about cap gains.

 

[youbet]

Personally, I think you are making this much more complicated than it should be, especially since we're talking about a relatively small amounts of money per child. I'm not sure the money management education you're envisioning is going to take place. They need to be involved all along, not just as the recipients of a gift from your portfolio in their mid or late 20's accompanied by a folder of the brokerage statements accumulated over the years.

But, if having your brokerage house track the history of four separate accounts so you easily have the history available at your chosen gift time is your goal, just open four accounts. Give each account a "nick name" (probably each kid's name) and check with your broker to see if you can set up "view only" privileges for the kids as they get older. Don't do TOD unless you investigate the implications of doing so for a minor.

The assets in these four accounts will be taxed and subject to the various investment rules just as if the assets were in your main account.

At tax time, you'll have four additional accounts to download into your tax software. If you pay someone else to do your taxes, this may result in an extra charge.

You're a thoughtful aunt to be involved in the kids' financial education and to have future gifting to them in mind.

 

[Dash man]

You could set it up in custodial accounts, and just not tell them about it, but mention it in your will.
The nice thing about custodial accounts is only income above a certain level is taxable. I think it was $1,100 last I looked. You can sell and buy back every year or two and reset the cost basis, and the income won’t be high enough to be taxed.
When they reach adulthood, they can’t access the funds if they don’t know about them. At least not until you tell them or they read it in your will. It could just be a letter attached to your will, so you don’t have to change your will.

 

[Zona]

Thanks everyone for the replies. My aunt is in her 80s and still gifting checks to me on occasion even though I have told her that we are doing great and that she should spend the money on herself. Her philosophy is "give with a warm hand". I've taken that to heart -- any future checks from her or inheritance from that side of the family will go into these four brokerage accounts, so perhaps over time the dollar amounts will be more substantial than the initial setup. When the time comes I can tell my nieces and nephews that this gift account is many years in the making from their grandmother (my mom), great-aunt, and great-grandmother, as well as from me. Hoping to be able to continually teach them age-appropriate lessons about money and saving and LBYM as they grow. Thanks again everyone for thoughtful replies!

 

[Zona]

But, if having your brokerage house track the history of four separate accounts so you easily have the history available at your chosen gift time, just open four accounts. Give each account a "nick name" (probably each kid's name) and check with your broker to see if you can set up "view only" privileges for the kids as they get older. Don't do TOD unless you investigate the implications of doing so for a minor.

Yes, exactly, each account will be nicknamed/earmarked for them. I confirmed that our brokerage can give them a view-only login (if desired at an age-appropriate time) and that eventually I could either add them as a co-owner of the account or just add them and remove my name when it is time to fully gift it to them. They wouldn't even need to open a new account, and would have all the history.

 

[tulak]

I like this idea. I do something similar with larger amounts, except the beneficiaries are over 18 now. I pay taxes and reinvest the dividends. I’m fine with that. I have the recipients listed as TOD, but for all practical purposes, I own the assets.

Sure, they’ll eventually have to deal with the original cost basis, but I’m ok with that. They’d have the same problem if they were investing on their own. And if they’re spendthrifts, so be it. I do plan to give them the money once they hit a life milestone, get married, buy a house, etc. But if at some point they blow the money, well, I hope they at least have a good time.

Gift taxes could become an issue, but if that happens, then I can transfer over multiple years to the max limit. I’m sure they won’t complain. Or I gift it all at once and deal with the consequences. I don’t think it’s a big deal either way.

I use VTI, which is what I’d recommend and would work well for you, since you don’t have to worry about any TLH or wash sales in the future.

It’s a great gesture and I’m sure your nieces/nephews will appreciate it.

 

[Lewis Clark]

Perhaps while the kids are <18 I name my sibling (their parent) as primary 100% beneficiary and the child as contingent. Then when the child turns 18 I change the primary beneficiary to the kid. Then I can hold onto the account until their mid-20's and transfer ownership in-kind at that time.

If the parent is the primary beneficiary when you die, the parent gets the funds. You may want the parent to pass the funds on to their kid. But there is no guarantee the kid will ever see the money. It depends on the parent.

 

[Zona]

I like this idea. I do something similar with larger amounts, except the beneficiaries are over 18 now. I pay taxes and reinvest the dividends. I’m fine with that. I have the recipients listed as TOD, but for all practical purposes, I own the assets.

...I use VTI, which is what I’d recommend and would work well for you, since you don’t have to worry about any TLH or wash sales in the future.

Thanks for your reply, tulak. It's helpful to hear from someone who does it this way. If you don't mind sharing some specific info, I have a couple questions:
1. now that the beneficiaries are over 18, do they know about these accounts? Or are you just keeping them to yourself until the time is right to give?
2. If the beneficiaries are aware of the accounts, how early did you let them know and are you using the accounts as a teaching tool in some way?

Appreciate the recommendation for VTI. We do hold that in our pre-tax accounts (because it is different enough from VOO & SPY for tax-loss harvesting) and since I'm not intending to TLH in these gift brokerages (buy & hold only), I imagine there's no danger of a wash sale with VTI. That'll probably be where I put it just because it is a broader index than just holding the nasdaq.

 

[Zona]

If the parent is the primary beneficiary when you die, the parent gets the funds. You may want the parent to pass the funds on to their kid. But there is no guarantee the kid will ever see the money. It depends on the parent.

True. I think I can trust my siblings to hold on to the accounts for their kids. And if not...well I can't control that, I guess, and that's okay. I wish I could convince my sibs to set up their own brokerage accounts for themselves (I have tried many times) but they are intimidated by "stocks" and haven't even started the first step of opening an account. (Both have retirement accounts and contribute to them, so that is good!) The fact that neither sibling feels comfortable investing in an after-tax brokerage account is part of why I want to do this setup for my nieces/nephews so that they learn about the benefits of "invest early".

 

[tulak]

1. now that the beneficiaries are over 18, do they know about these accounts? Or are you just keeping them to yourself until the time is right to give?

2. If the beneficiaries are aware of the accounts, how early did you let them know and are you using the accounts as a teaching tool in some way?

They don’t know about the accounts and they’re not used as a teaching tool. I plan to surprise them with the accounts when they achieve a life milestone (aka, are settled), probably when they buy a house so they can use it for furnishings.

Luckily, they seem to have learned good financial habits without these accounts.

Plus, the amounts, relatively speaking, are small. To really grow wealth, it’s not enough to contribute once or occasionally, you need to be saving 15%+ of your gross long-term. That’s hard to teach with these accounts. And I think if you’re not the one saving your own money, you won’t really get it.

So I look at these accounts as an unexpected windfall that will hopefully ease their path into adulthood.