Should I Gift My Kids Money While I am Alive? Or Let Them Inherit It?

In today's challenging and expensive economic environment, many young adults in their twenties and thirties are struggling to find stable footing when it comes to their finances. Whether that's struggling to find that perfect career that can help them pay off their student debt, saving enough for a down payment on a first home, or simply having extra cash each month to pay for things like childcare. These common issues are causing many parents in retirement to rethink their own situation by contemplating whether or not they should step in to help and, if so, how.

Welcome to Retired-ish. I'm your host, Cameron Valadez, and today, I want to share with you some of my experiences over just the past few years when it comes to helping out your adult children financially. Now, I know this can be a touchy subject. There are many of you out there who think and feel that you would do absolutely anything for your children financially, even if it were to your own detriment, which is fine. To each his own. No judgment there. Then, of course, there's those of you who are like, hey, I worked my butt off to save my money, and I'm spending all of it. The kids are on their own and trust me, that's fine too.

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But there are also many of you who maybe would be willing to help your children because you want to see them thrive and enjoy life as long as it doesn't cause you to go overboard and potentially ruin your own livelihood now in retirement or in the future. It is these types of situations that I want to address in today's episode. And besides the decision of whether to help from an emotional and feasibility standpoint, there are also other potential issues, such as taxes, which at the end of the day can further reduce the nest egg you're able to live off of and or the total amount of money you would like to pass to your kids when you're gone. My goal is to share with you actually a story, which is a real-life situation that I dealt with over the past several years. It includes many of the emotional hurdles and thoughts, decisions, and financial consequences you might encounter when faced with a decision like this. So, let me start by setting the stage for this couple and what they were facing. Then, we will dive into their different options.

So we have a husband and wife, both retired in their mid to late sixties, both fortunate enough to have really healthy pensions from their former employers, and they actually receive a small social security benefit, which is enough money altogether each month after taxes to sustain their lifestyle in retirement. Actually, they also have a small amount of rental income as well, around $1,000 per month. And as far as assets go, so the wealth that they've accumulated, they have a small inherited IRA from one of their parents, which actually must be fully distributed and taxed within the next ten years due to some recent regulatory changes.

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They have one traditional IRA, which they will have to start withdrawing a minimum amount out of and pay taxes on starting at age 73 due to the required minimum distribution rules. They also have a sizable investment account held in the name of their revocable living trust, which contains mostly stocks that were actually inherited from one of their parents. And these stocks have had significant capital gains since the parents passing, which is a good thing. They also have their home that they own. They have a second home, or we can call it a vacation home, that they actually let their adult son live in rent-free. This property was inherited free and clear as well, similar to the stocks, and this home does not have any mortgage on it. They also have one rental property that was also inherited free and clear from the same parent. But, again, it is a rental property. They are renting it out and receiving that rental income that I just mentioned.

And the only debt they have is about a $300,000 mortgage with a 3% interest rate on their $800,000 home. And although they have multiple types of assets in different places, the majority of their net worth, or in other words, the majority of the value of their current estate, is in their personal residence as well as the other two properties since they were inherited free and clear and don't have the same tax implications as let's say the retirement accounts. Similar to the stock portfolio, the rental property and the second home also have benefited from outsized appreciation in recent years. So, think from 2020 to 2024. Therefore, there are capital gains embedded in these properties as well. That means they've gone up significantly in value, similar to what could happen with a stock portfolio. Right? Now, that means the couple would pay capital gains taxes if they chose to sell these properties since they have not lived in either one of them in the past as a personal residence.

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In addition, they have the experience of taking care of aging parents and know what the cost of long term care looks like. Their plan has been to self-fund a potential long-term care event using the assets they've accumulated and their lifetime pensions that adjust with inflation. Any money that isn't spent on their own care will likely go to their four kids. That's essentially what they want to have happen. Now, their kids are all adults and out of the house, and all have pretty steady careers in their fields of study. So, all in all, this couple has a a pretty good situation, a great situation, in fact. They have an adequate and reliable income stream. They have reasonable debt. They don't have any consumer debt, and they have a sizable amount of diversified assets. They have a positive net worth and a high probability of being able to leave a financial legacy to their kids with minimal tax impact since most of their assets will produce what is called a step-up in basis upon their deaths.

Now, if you're not familiar with this step-up in basis concept, hopefully, I can break it down for you in a simple example. Let's say you purchase an asset that is not in a retirement account for $100,000. That would be your basis. And let's say that you held that investment for years, over a lifetime even, and it grew to $300,000. You would have a $200,000 gain that would be taxable if you disposed of that asset or sold the asset. Now, if you were to hold it and then pass away, your beneficiary or heir that is going to inherit that asset will actually get the basis stepped up to the value at your date of death.

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So, in this hypothetical scenario, it was $300,000. So, if your beneficiary then inherits it and it's worth $300,000, now their basis is $300,000 and they no longer have a gain. So, if they were to, let's say, turn around and sell it the very next day, there likely won't be much, if any, tax consequences.
Okay. So now that we have a little bit of background on their situation let's throw a wrench into the mix. Over the last three years, one of their kids, let's call him child number one, has blessed them with two little grandchildren. Super exciting. And they are very, very happy.

However, with that comes different wants and needs of child number one. With two younglings who are both not only walking but running, child number one now needs daycare for his younglings three days a week for about nine hours each day because he and his spouse work. Thankfully, grandma and grandpa are willing to help take on the babysitting responsibilities the other two weekdays. In addition to daycare, child number one feels that the house that he's currently living in, which, again, is the second home that his parents own, is starting to feel a bit too small to handle the entire family and the backyard just doesn't have much room for the kids to play and learn how to ride bikes, etcetera.

Because child number one now needs to pay for three days of daycare every week, which is pretty expensive these days for two kiddos, most of his discretionary income now goes towards paying that bill. That being said, he's unable to save up for a down payment on a bigger home. He doesn't have much savings to begin with and no equity in his current home because child number one is the one living in the second home, which is owned by mom and dad, but he's getting to live there rent-free. This situation is not out of the ordinary.

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There are many families out there with very similar situations to this retired couple. Some might be pretty much the same, and others might just be a slight variation in facts and circumstances. So, naturally, Mom and Dad, our retired couple here, they want to be able to help out as best they can financially if they can afford to help without jeopardizing their own future. That means figuring out how to help with the expensive daycare costs and maybe how to help child number one get into a bigger home to better support their son's growing family.

So the question becomes, what should they do? What can they do? Well, ultimately, they can, of course, do whatever they want. But whatever they choose to do or not do can not only produce a financial and tax impact that's fairly significant, but it can also have an impact on the family dynamics, which is probably more important. And I wouldn't let potential tax ramifications alone drive their decision.

When making decisions like this, it's about what you want for you and your family and your legacy. And if there are multiple ways to go about helping, it's about identifying the most efficient way to do so when it comes to the money and the taxes. If they want to see their children enjoy the money they might otherwise inherit while they're alive, they should plan on gifting the money rather than letting the kids inherit it. But, again, there are some things to consider first to see what's the best way of going about it. In this particular scenario, there are multiple things to consider. Let me go through some of the different things that I would want them to look into before making a decision. And the first is, what is the current family situation? If you were to help out, do you have the means to without jeopardizing your own goals and retirement income? In this couple situation, we know their income is already adequate, and they don't need to draw from their investments and their retirement accounts necessarily to supplement their ongoing income need. We do know, however, that they may need some or maybe even all of their assets at some point in the future if one or both of them had a long term care need.

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For example, if they both eventually required in home care or maybe one of them has significant memory issues, this can cause an extended long term care need for years and cost a lot of money since they chose to self insure it and not purchase any sort of long term care insurance. Now, these bills can easily add up to be well over $100,000 per year for the two of them. This could drain their assets considerably and potentially leave little to nothing for the kids.

However, if they were to give too much to children, there will likely be significant issues if care is eventually needed, and the kids may feel obligated at that time to then support the parents physically and financially. It should go without saying that they shouldn't give them money they might need for care or money from retirement accounts if they needed it to support their other retirement income, which isn't the case here, but it is in many other situations. They have more time to save and plan for retirement than you do. The second thing I would consider would be this couple's own tax situation. If they were to help out child number one by gifting him a lump sum of money now while they're alive in order for him to buy a new home, they would need to liquidate a substantial chunk of their assets.

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Because all of the assets have capital gains embedded in them, like we learned earlier, they will likely pay a substantial amount in federal and potentially state taxes if their state has a state income tax. In addition, because they have pensions and social security coming in, they are basically already locked into a base tax bracket. In other words, there likely aren't any years where they may be able to strategically move into a lower tax bracket because that income is just coming in. If they were to recognize more taxes by selling assets, this can potentially cause other additional taxes such as additional Medicare surcharges, more taxation on their Social Security benefits. It might bump them into a higher income tax bracket, and possibly an additional tax known as the net investment income tax, and that's just to name a few.

Now one of the other most important things they should consider are their adult children's current wants versus their actual needs. For example, can child number one and his spouse find other ways to solve this issue on their own in due time? It is just that they want these changes to happen sooner than later because they know his parents may be willing to help and have the money to do so? In other words, do they truly need the help and their parents are the only option? Now, we will circle around back to this in another example later. Not only should they consider their own tax situation, but also their kids' tax situation.

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Again, they shouldn't let taxes alone dictate their decision, but a little education for their children around taxes and the impact they will have on the money that they may inherit may change their mind from simply wanting to instead helping maximize the wealth the parents have accumulated for them. And again, we will get into an example of this later as well. And lastly, how might this impact the family dynamics? So let's think for a second. Remember, they have four adult children. If they were to gift money or assets to child number one, would the other siblings feel entitled to a gift as well? Would this cause family tensions by being unfair? Do the other children even have a need for any money right now? What is their personal situation like? Even if they don't need any money now, will they still feel that a gift to child number one to use now while they're young would be unfair? If the parents did in fact decide to make gifts of equal amounts to all of the children now while they're alive, will that eliminate all of the extra funds they had set aside for care?

As you can see, this can present a lot of issues that might not be so obvious at first, but can come to roost later. After thinking through the extra dynamics of how this could play out and making a decision, we then should look to see whether or not there are multiple ways of going about doing so. There are many different ways to go about this in this situation and strategies to consider, but for this case and this episode, I want to go through just a hypothetical decision by the parents. Now, let's say the parents decide that they want to hit two birds with one stone and help child number one buy a bigger home that is near them so that they can also devote one or two more days to the babysitting.

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Therefore, they decide to sell the second home that child number one currently lives in so that they can continue to rent the other property and so that they can retain a bucket of more liquid assets in the investment account with the stocks just in case they need to access it quickly in the future. By doing so, they will recognize almost six figures in taxes to the IRS and the state due to the capital gains on the home. They then give child number one all of the proceeds as a down payment for the bigger and more expensive home, leaving him with a more manageable mortgage payment. In this case, they have given child number one a substantial gift of money well into the six figures, and a good chunk of it was given to the tax authorities and it did not stay in the family and go to anyone else.

Looking at this from a tax perspective, this wasn't necessarily the best decision since if he and the other children were to inherit that second home, they would have received that step up in basis and the capital gains would have essentially been erased, leaving them all with a larger inheritance. But again, their focus was on helping their son, not the taxes, which is okay.

So now that everything worked out for him, what about the others? Well, let's say the parents decide they do prefer to see all of their children enjoy some of the family wealth while they're still alive. The other children didn't necessarily need any money at this point, but they felt that this was unfair.

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So the parents brought them to the table to discuss. The other kids felt that although they didn't need the money yet, they wanted their share so that they could start investing it themselves to begin building wealth just as their parents have. They each felt that they could either invest in the markets or buy rental property, etcetera, to set their own families up in the future. One child actually asked for the parents to give them the rental property so that they could start off with an investment that was already working for them. Here's where a little education and family discussion can be extremely beneficial. So let's circle around back to considering the children's wants versus their actual needs and how this can impact the potential outcomes. Now, the other children had homes. They had enough income and they were happy with their lives so far and they even each already had begun saving for their own retirement and their own kids higher education to an extent.

They all just wanted to use this money to start building additional wealth on their own. In this case, the parents could gift them the money or assets for them to invest as they please, but there would likely be significant tax ramifications by going down this road. Again, this is because they would have to gift the kids assets that have large capital gains, and when you do that, the kids take on the parents' cost basis. This means that if the kids sell the assets and reinvest them differently in their own way or maybe even keep the assets and sell them later for their own goals, they will pay the taxes on those gains. This is opposed to inheriting the assets. When inheriting the assets, the basis would be stepped up at their parents' death and those gains would largely disappear. So if the kids receive gifts and ultimately pay the taxes, that means they will likely cut their inheritance by 20 to 30%. This could be 100’s of 1,000’s of dollars lost to the tax authorities.

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So, is there a better way to go about this? And the answer is yes. And it can actually be quite simple. The parents are already investing the assets and because the kids don't actually need it for decades to come, why not let the parents continue to invest the assets for them and simply pass them at death, therefore preserving most, if not all of the money. Then, each of the other three children can take their share without losing anywhere from 20 to 30% or more to taxes. Now, if the parents were to amend their trust and or the titling of the various assets that they own, they can essentially earmark different amounts or assets to each of the kids. They can do the investing for each of the children and save a significant amount of the estate. This will likely leave the kids in a much better place financially. In addition, doing it this way can prevent the kids from potentially squandering the money prematurely since they won't have control over it yet.

For example, let's say the child who mentioned that they wanted the rental property decided to sell it three years after it was gifted to her because she got the itch to move to the beach and buy a really expensive home and maybe a fancy car to go with it. Her intent originally was to invest the money for her own future but hey, we're all humans, things change, and we make emotional decisions all the time. Now, you may be thinking, well, what if the parents ended up using most of the money for their own care and child number one got away with a getting a chunk of money from mom and dad? Well, this is where the planning can get quite complex and where you might consider having a financial planner and an estate planning attorney come into play. You may need to get even more creative by exploring unique strategies using maybe things like life insurance or long term care insurance or even something like a shared equity financing agreement, for example, which is definitely beyond the scope of this episode, but again, speak with a professional if you have a complex situation. This situation I gave you is just one example of how things can turn out. There are obviously many ways to strategize in a situation like this and or others. And in this situation specifically, them simply going to their attorney and telling them that child number one should no longer have any portion of a potential inheritance because we already gave it to him is just not going to cut it. It's actually much more complicated than that.

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That wraps up today's show. Hopefully this gives you some insight if you're wanting to help your children and their future endeavors. If you find the information and the strategies I've provided on this show actionable, valuable, and insightful, please subscribe to or follow the show on your podcast app. While you're at it, check out the Retired-ish newsletter to get more useful and easy to digest information on retirement planning, investing, and taxes once a month straight to your inbox. And, of course, if you want to learn more about the topics I went over in the show or you want to ask a question to be answered on a future episode, you can find the links to the resources we have provided in the show notes right there on your podcast app, or you can head over to retiredishpodcast.com/54. Thanks again for tuning in and following along. See you next time on Retired-ish.

Disclosure [00:23:43]:

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