3 ways to give your godchild (or niece or nephew) a financial boost

By Amy Fontinelle
Amy Fontinelle is a personal finance writer focusing on budgeting, credit cards, mortgages, real estate, investing, and other topics.
Posted on Nov 21, 2018

What can a godparent, aunt, uncle, or close family friend do for a youngster to help them succeed in life?

Financial advisors and personal finance experts point to three versatile ways of doing that:

In addition, there is the possibility of setting up a Roth IRA or establishing a transfer account or trust.

Discuss your plans with the child’s parents

Of course, you shouldn’t take any steps without talking to the parents first.

“They have a right to know, and it may very well impact their thinking,” said Morris Armstrong, owner of Armstrong Financial Strategies in Cheshire, Conn., in an interview. “Assume that the parents are middle income and may have a slew of pressing needs, but sending junior to college is a priority,” he continued. If they don’t know about your plans, “they may very well make unnecessary sacrifices in other areas, such as maybe family vacations, home upgrades, quality of life issues, in order to save for the college fund, only to be surprised that you socked away $75,000.”

Had that been known, the parents might have made different choices—choices that could have benefited the whole family. Keep that in mind if you’re considering keeping the gift a secret until later in the child’s life.

Set up a 529 college savings plan

One of the more efficient ways to help a child you care about is setting up a 529 college savings plan.

“Not only can this benefit the child, but most states allow you to get a state tax deduction for your contribution,” explained R. J. Weiss, a CFP® professional and founder of the personal finance site The Ways to Wealth, in an interview.

A 529 college savings plan, named after Section 529 of the Internal Revenue Code, provides a tax-advantaged way to put aside money for college. The money can be used for tuition, fees, room, and board at a college or university. In addition, with the changes made under the 2017 Tax Cuts and Jobs Act, up to $10,000 in 529 plan money can be spent each year on tuition for elementary and secondary education. (Learn more: Section 529 Plans )

Earnings grow within the account tax free, like they do in a retirement account. And earnings withdrawn from the 529 plan to pay for qualified educational expenses are not taxable at the federal level and may not be taxable at the state level.

Contributions can be invested in mutual funds, exchange-traded funds, target-date funds, and more. 529 plan assets do affect a student’s financial aid eligibility, and they affect it differently depending on whose name the assets are in. But 529 assets can also reduce the amount a student or parent needs to borrow.

Unlike retirement savings accounts, 529 plans do not have annual dollar limit on contributions. But there may be maximum aggregate contribution limits on the account balance for the life of the account, which vary by state. And you do need to be aware of gift tax rules. In 2018, individuals can make an annual exclusion gift of $15,000 per person without paying gift taxes. So you could gift your niece $1,000 in savings bonds and another $14,000 in 529 contributions, for example.

With 529 plans, you can front-load your annual exclusion contribution by contributing a lump sum of between $15,000 and $75,000 and categorize your contribution as being spread out over five years for gift tax purposes. Doing so can boost the account’s value over time by giving investments more years to grow.

Just make sure any other gifts you give the same child do not push you over the $15,000 per year threshold or you’ll have to file a gift tax return. Unless you indicate on the gift tax return that you are front-loading the 529 contribution, gifts above the annual threshold count against the lifetime gift and estate tax exemption, which stands at $11.18 million per person until December 31, 2025, and reverts to $5.49 million thereafter.

Armstrong said college 529 plans and small trusts seem to provide the most protection for givers who want a say in how funds are disbursed, and that in his 20 years of experience, when people are giving gifts over many years, they really do wish that they could control how the money is spent. (Learn more: 529s underutilized by many college savers)

Investigate life insurance

The purpose of life insurance is protection. But certain types of life insurance acquired early in life can open doors down the road.

For instance, a permanent life insurance policy on a child can be extremely valuable should the child die or suffer a serious health event that renders them uninsurable, said John Essigman, managing member at John Essigman Wealth Advisors in Cleveland, Georgia. But, the cash value could be used to help fund some important steps in life. (Learn more: Understanding cash value )

For example, the child could use a life insurance policy loan to help pay for college. The money would not be considered income and would not affect financial aid, Essigman explained.

However, tapping the cash value of a permanent life insurance policy increases the chances that the policy will lapse, and reduces the cash value and death benefit.

Further, Essigman cautioned, “A cash value life insurance policy that is surrendered or lapses could become taxable. Be careful when using life insurance, as there are various complexities and traps to consider.”

You’ll also need to weigh the cost of a permanent policy against the benefits it could provide. In addition, buying a life insurance policy for someone who isn’t your child or grandchild can present additional challenges. A financial professional can help navigate the requirements in such circumstances.

What about buying life insurance for yourself, or increasing your policy limit, to benefit the child after you pass away?

Essigman said this strategy is a “great way to leverage a life and leave a legacy. However, you do not want to name an underage child as a beneficiary, as they will not receive the funds until they are of age.”

Instead, “a guardian, conservator, or state-appointed trustee will control the funds until they reach the age of majority,” he explained. “An option is to name a trusted adult as beneficiary with instructions on how to use the funds,” but this entails some risk since an adult you trust can marry someone you don’t trust or be influenced by family politics.

Another shortcoming of this strategy is that you don’t know when you will pass away or what the child’s financial situation will be at that time. But a benefit is that you can remove them as a policy beneficiary at any time.

You could also buy a separate policy and establish a trust to own it or be the beneficiary. Using a trust removes the policy from your estate for gift tax purposes and offers a higher level of control over how the policy’s cash value or death benefits are used, Essigman said. “Be aware that a trust may increase the complexity and cost depending on structure and who is named as trustee,” he added. (Learn more: Gifting life insurance for kids: 3 reasons)

Introduce them to financial planning

“Starting a young person in their adult life with good financial advice is a gift that will keep giving for decades,” said CFP® professional Kristi Sullivan, owner of Sullivan Financial Planning in Denver.

To that end, a great gift is an hour or two with a financial advisor, planner, or professional.

“Many planners offer hourly rates for unbiased advice,” Sullivan said in an interview. “You could ask a planner for a gift certificate to meet with your special relative.”

Sullivan explained that if she were meeting with a recent grad, she would advise them to start saving 10 percent of their income, no matter how little that might be, until they have at least three months’ worth of expenses set aside. Once they have that, shift to putting 10 percent of pay into a retirement plan. She would ask the grad to come to the meeting with numbers on their income, monthly spending, and debts, and use those numbers to start the conversation.

Why hire a professional to sit down with the child even if you could tell them all this stuff yourself for free? Because young people sometimes have an easier time accepting advice from people they aren’t related to. Also, they may not be comfortable sharing information about their income, expenses, and debts with relatives or family friends who might share that information with others or use it to scold them or question their choices. (Learn more: Meeting your financial advisor for the first time)

Other options: Roth IRAs, transfer accounts, and trusts

Depending on circumstances, some godparents, aunts, uncles, and others may want to consider setting up a Roth IRA, transfer account, or trust for that special youngster.

But such vehicles can be complicated and have tax implications and filing requirements. Many people opt to consult a financial advisor before making such moves.

A Roth IRA is a tax-advantaged retirement savings vehicle. After-tax money can be contributed to this account, invested in a variety of ways, and grow tax free forever. The IRS doesn’t have any minimum-age requirements to put money in a Roth. So it’s possible for an adult to open a custodial Roth that allows the adult to retain control of the account until the child reaches the age of majority, but save money in the child’s name.

But those named in Roth IRAs must have earned income and file income tax returns, something not always usual for children. And contributions to someone else’s IRA can’t be greater than that person’s earned income.

Similarly, adults can establish an account governed by one of two acts that most states have passed: The Uniform Transfers to Minors Act (UTMA) and the Uniform Gifts to Minors Act (UGMA). Children younger than 18 years old can’t own securities and other monetary assets except through a custodial account or a trust. These accounts let adults give money or other assets to children without turning over control of the account until the child grows up.

Some people opt to set up trusts, basically an account or fund typically held or managed by a financial institution or professional for a beneficiary ― in this case a godchild, niece, or nephew.

Trusts can be relatively straightforward or highly complex, depending on the financial circumstances and assets of those involved. Most people opt to consult a financial advisor or service about what types of trust structures are available and suitable for their situation. ( Learn more: Is a trust right for you ?)

Conclusion

There are many ways to give that special child in your life a leg up financially. What’s appropriate depends on your circumstances, the child, and the parents. Weigh your options carefully, and perhaps consult your own financial professional for guidance.

Learn more from MassMutual…

Money and children: Teaching by age groups

Possible college gifting moves for your grandchildren

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The information provided is not written or intended as specific tax or legal advice. MassMutual, its employees and representatives are not authorized to give tax or legal advice. You are encouraged to seek advice from your own tax or legal counsel. Opinions expressed by those interviewed are their own, and do not necessarily represent the views of Massachusetts Mutual Life Insurance Company.