What would you want to be true about a large gift to your child five years after you make it? That you can see how they handled it, or that it is still intact no matter what happens in their life? Those are different goals, and on a recent episode of the Scholar Wealth Podcast, our advisors debated them under one heading: “direct gifting to your children versus gifting into an irrevocable trust for their benefit.” The honest answer depends on how large the gift is, and on whose estate it is likely to end up in.
What Direct Gifts Teach
A direct gift builds the skill you hope your children will need later. The annual gift tax exclusion is $19,000 per recipient, so you can give $19,000 to each child, and a married couple can give $38,000. Once a child marries, you and your spouse can each give to the child and to the child’s spouse, which brings the total to $76,000 a year.
Those gifts are simple, and they let your child learn to invest while you are still around to answer questions. They also show trust. A child who has handled $19,000 well is better prepared for a larger sum. It also gives you a chance to see how your child reacts to money, and how their spouse does, before you decide how much more to transfer and in what form.
What a Trust Adds
A trust adds protection, which becomes more valuable as the amounts grow. When the trust owns the money instead of your child, the money is generally less exposed to your child’s creditors and to a divorce settlement.
A trust also lets you set the rules. Distributions can be limited to health, education, maintenance, and support, and an independent trustee can have discretion over the rest. That matters in the situations nobody wants to plan for: a child who spends carelessly, a spouse or partner who pressures them, or a struggle with addiction that is not their fault but still drains an inheritance.
When Estate Size Forces the Question
If your projected estate sits above the federal exemption, currently $15 million per person or $30 million for a couple, the discussion changes. Gifts made now remove future growth from your estate. But gifting outright can solve your estate tax problem by handing it to your children, whose estates then compound the same assets.
A dynasty trust can avoid that second layer. If you allocate your generation-skipping transfer tax exemption to the gift, the trust can benefit your children and grandchildren and compound inside the trust, instead of inside each generation’s taxable estate.
Complexity Has a Cost
The more complicated the structure, the more it has to earn its place. If your estate is comfortably below the exemption and your child is financially responsible, a trust may be a tool for a problem you do not have. A trust is built to last, so you could end up with an instrument that outlives the problem it was meant to solve, along with the legal fees and administration that come with it.
There is also a cost to withholding. If you hold back everything until you are gone, your child may receive a very large sum with no experience handling anything close to it, and no chance to ask you for advice.
A Hybrid That Ramps Up Over Time
For many families, the answer is both. You make annual exclusion gifts directly, increasing them as your children grow into responsibility, while a much larger one-time gift, perhaps $10 million to $15 million, goes into a trust so future appreciation leaves your estate. If you are in that position, we, your advisors, can help you test each piece against your own numbers.
Start with two numbers: your projected estate measured against the $15 million exemption ($30 million for a couple), and the $19,000 you could give each child this year to see how it is handled.
This post is adapted from a recent episode of the Scholar Wealth Podcast. For more perspective on balancing control and independence when you give to the next generation, watch the full podcast episode here.