Wednesday, December 20, 2023

The Gift That Keeps On Giving

We just had Black Friday and Cyber Monday. The Holiday Season is approaching. Everyone is rushing to buy gifts to the people that are most important to them. An expensive gift shows appreciation, and your love for the other person.

At least that’s what the marketing departments at some of the worlds largest companies have convinced us to believe.

People rush to overcrowded stores, and scour the internet for great shopping and gift ideas. I am guilty of that as well, as I bravely ventured to the parking lots of Target and Bed Bath and Beyond. I also set foot in the stores. Perhaps I even dared to buy a few things.

At the end of the day, everyone gets more stuff, filling our basements, landfills, storage units.
Parents usually feel the pressure to provide that exciting gift for their child, which is promising to develop them, entertain them and teach them important lessons. Kids will play with the toys for a while, until they end up gathering dust in a basement or just thrown in the trash.

I have come to the conclusion that no one will remember your gift ten or twenty years down the road. It is very rare that this gift will be a life changing event.

I believe that the best gift to provide to others is the gift of stock. I think that the best gift should be buying quality dividend paying stocks to recipients.

The gift recipient will receive dividends for decades. Every time they receive a new dividend check, and every time that dividend check increases with dividend growth, they will think fondly of the person that gave them that stock.

For example, if your great grandfather bought just one share of Coca-Cola stock in 1919 for $40,and reinvested those dividends, he would have left an estate worth $21 million today from just that one investment. This investment would generate close to $50,000 in monthly dividend income, which has increased for 60 years in a row.

I believe that the best holiday gift is the one that keeps on giving. This is why I prefer providing the gift of stock to the people closest to me. Namely, my offspring.

I still do actual presents, but I supplement them with a deposit and an investment in an investment account in their name. Time is the most valuable asset that a young person has. The ability to sit on an investment made at a young age, and then compound it for many decades is very helpful in accumulating wealth.

There are many ways to give the gift of stock. I would focus on the cheapest ways, and look for ways to minimize fees and costs as much as possible. There are a myriad options to accomplish this. Each will be available to you depending on your individual circumstances. However, the optimal one will vary from person to person, which is why I would encourage you to speak with a CPA, particularly if these options seem overwhelming.

One way of giving stock as a gift is by opening a custodial account. You control the stock as the adult, and the child becomes its owner at the age of 18 or 21 ( depending on your state). This is as simple as opening a new brokerage account. 

There may be tax implications however.

For 2022,  the first $1,150 in qualified dividends are not taxable. 

The next $1,150 is the child's marginal tax rate. 

Anything above $2,300 is taxed at the parents' marginal tax rate.

The tax rates on dividend and capital gains income for minors are more onerous than the dividends and capital gains rates for their parents. 

Taxes can become more complicated if the child has earned income too. I'd touch base with a CPA/Tax Advisor to address any specific situations.

Fidelity and Schwab have interesting information on the Kiddie tax. They also refer you to IRS publication 929. It's excellent bed time reading.

Depending on your individual circumstances, and if you do not want to deal with stepping on to the kiddie tax, it may make sense to just open an account in your name. You can then keep the funds in your name, but mentally earmark it for the benefit of the child. At a certain point in time, you may decide to transfer the stock as gift to the younger person. Brokerages like Fidelity can easily accommodate these requests, but may charge a small fee for it. You also need to pay attention to the gift tax. Right now, all you need to know is that a gift of up to $15,000 that you make to someone is not subject to a gift tax. If you are married, each partner can donate securities worth $15,000, for a total of $30,000. The recipient gets your cost basis in the stock.

When the young person inherits the stock from you, their cost basis will be the price of the security at the date of your death. That’s the third way of getting the gift of stock, but it is the worst way for the person who makes the gift of stock.

A fourth way to give the gift of stock is by using designated tax-deferred accounts. If the minor has some earned income, you can let them spend it or do with it as they please. You can then go ahead and put the same amount as their earned income in a Roth IRA. You are then free to invest in anything you want, without worrying about taxes. The money will compound tax-free for decades.

Alternatively, you can put the money in a 529 plan or an Educational Savings Account. There are limits to how much you can invest in each account, and the money has to be used for certain purposes. I do not like the restrictive nature of these accounts, the taxes and fees if the money is withdrawn and not used for education. I also dislike the fees on the 529 accounts in general. There are limits in 529 accounts to what you can invest the money in. For educational savings account, the money has to be disbursed by the recipient’s 30th birthday.

The last way is the most common way for richer individuals to gift stock to their beneficiaries. It involves setting up a trust fund, whose sole purpose is to hold the stock for the beneficiary. The trust fund disburses dividends, interest and income to the beneficiary, but usually is a separate legal entity. This provides protection to the trust assets, and the beneficiary gets to enjoy a stream of income over their lifetime. Trust and estate is a very complex matter, which will not be explained by a single blog article. The biggest advantage of a properly structured trust is that it eliminates the estate tax for the wealthy individual, while also showering their offspring with rising dividends for decades to come. That’s what the Rockefeller family has done in a nutshell. You definitely need to engage a qualified professional, or a team of professionals, before even thinking about starting a trust fund. If the Rockefellers can teach us anything, it’s that a proper trust fund planning can provide for several generations.

Today, we discussed gifting dividend stocks as presents, rather than spending the money on gifts that no one will remember in a decade or two. Dividend stocks are the gift that keeps on giving, as they will provide dividend income for decades to the recipient. There are different ways to accomplish this task, which can be used as tools to do what is necessary in order to give the gift that keeps on giving.

Relevant Articles:

Stockpile Brokerage Review
Five Stocks Delivering the Gift that Keeps on Giving
How to turn $40 into $18 million
Roth IRA’s for Dividend Investors

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