My grandfather just gifted my infant son a cash gift for Christmas. We are very appreciative, but not sure where is the best place to put it financially. What do you advise?
Grandparents and great-grandparents are the best. Whether it is showering their grandchildren with toys, clothes, and books or gifting financial savings, grandparents can be amazing benefactors.
As the parent though, it can be hard to know what to do with a cash gift. Pocketing the money into your joint bank account feels like stealing, but you’re the one spending money for his benefit at this age. On the other hand, saving the money in a custodial account while you are having difficulty paying the bills doesn’t seem fair to the family.
I believe property rights are important even for babies, but family finances are blurry. If we merge the family assets into one big common pot and ask the question, there is an obvious location for where the gift should go:
Fund a Roth.
If you are not fully maximizing your family’s Roth IRA contributions, my first choice would be to fund a Roth IRA. It is the best tax planning location to save the money regardless of whose money it is.
As your child is an infant, I highly doubt they are making the earned income required to fund their Roth IRA, but you shouldn’t feel bad putting it in your own.
Saving and investing while you are younger is worth more because of the magic of compound interest. Thus, the family estate will be greater if you can store that money away in the Roth IRA. Alas, young is when it is the hardest to save. Family spending peaks with children and then tapers off later in life. At the same time, parental income starts small and trends upward.
Count some of your regular expenses for the baby as being from grandma and utilize the financial margin to max your Roth contribution.
By the time your children are old enough to want cash, you will likely have more margin in your family budget. At this point (or sooner), you can make your child whole, gifting them back the money out of your then surplus.
Fund his 529 account.
If you are already maximizing all of your family Roth options, the next step is funding a 529 account. Just this 2018, they changed the tax code to make elementary, secondary, and even some homeschooling education expenses qualified 529 expenses. This means that it is even easier to receive benefit from a 529 account.
Save it in a taxable account.
If you have already maxed your Roth and don’t need more in a 529 account, the next step is to save it in a custodial account (UGMA or UTMA) or a designated beneficiary account (Transfer On Death or TOD).
A custodial account is money that is legally the child’s property, but where you are the caretaker for the assets. You can withdraw to reimburse or pay for expenses that are for the benefit of the child. This includes food, clothing, diapers, and more. Basically, so long as you are the loving parent of that child, you will have qualified expenses. When the child comes of age (you pick 18 or 21 on account set up), the money becomes their outright and free of your control. Also, because the assets are legally the child’s, this money is not included in your estate should you predecease your child and a small amount of unearned income is taxed at the minor’s tax rate.
On the other hand, a designated beneficiary account is owned by you but has a designation on it so that if the account owners die the child (or children) will receive the funds. It is earmarking the money for them in your estate plan. This is a will substitute that avoids probate just like IRA beneficiaries do. The money is legally yours, however, so you can use it however you want to without any questions.
Both of these accounts help to keep the assets out of your day-to-day checking account or taxable emergency fund, so you can set aside the funds for your child’s benefit so it doesn’t fall plague to mindless spending.
Regardless what you do, make sure your baby knows how much their grandparents or great-grandparents love them and that they were so generous with their assets.
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