Managing Financial Ties to Your Kids

O.K., so you're willing to provide monetary assistance to your adult children. Here are some ways to do it that preserve wealth and minimize tax liabilities

by David Bogoslaw

Talk to people between ages 55 and 65 and they'll tell you: An empty nest doesn't necessarily mean you've stopped doling out worms to the youngsters.

Part of the reason older parents still provide financial assistance to young adults stems from the escalating cost of living, particularly when onerous payments on education loans deplete huge chunks of twenty- and thirtysomethings' salaries. Most people fresh out of college find it hard to afford the rent without help from home.

But another factor may be unique to the sensibility of the baby boomer generation. "The boomers' tendencies lean toward doing whatever it takes to take care of our kids. We do a lot for our kids," says Steve Slon, editor of the American Association of Retired Persons' bi-monthly AARP The Magazine. "When we see the cost of housing and education, we just get out our checkbook."

Researchers at the University of Michigan's Institute for Social Research reported in 2004 that 34% of adults between the ages of 18 and 34 receive financial assistance from their parents, and that the average total contribution during those 17 years is $38,340.

For most parents, the decision to help their grown children financially is too emotionally loaded to be bound by considerations of financial prudence, says Anthony Benante, a financial adviser at Baron Financial Group in Sarasota, Fla. "In our general experience, parents who want to help their kids are going to help them," he says. "And then you figure out how to do it."

Cash Gifts

Only when a request for help becomes a recurring need will his clients of retirement age seek out financial advice about the most cost-effective ways to provide support, Benante adds.

The basic building block of funding grown kids is a cash gift, which isn't subject to federal gift tax as long as each parent gives no more than $12,000 per year to any child or other family member. Parents whose gifts exceed that amount don't have to pay the taxes on the surplus right away. Instead, they are tallied against a uniform credit that is currently $1 million during a person's lifetime and an additional $1 million applied against the estate after death. The total uniform credit is scheduled to rise to $3.5 million in 2009, with the lifetime portion remaining capped at $1 million. (Read more on gifting strategies.)

What's less widely known is that parents can also directly pay their children's expenses—anything from rent on an apartment and medical bills to grandchildren's tuition. As long as they're paid to the billing institution, they don't count toward the annual gift-tax exclusion or the lifetime credit. The definition of medical expenses is fairly expansive and includes hospital visits and even health insurance. These kinds of payments can save parents from worrying about whether their kids' medical or other basic needs are being taken care of, Benante says.

Estate Structuring

Inevitably, some children take advantage of their parents' willingness to offer financial support, while some parents all too easily fall into the trap of enabling their children's dependent behavior, he says.

When Benante meets with such clients, he alerts them to what's happening to their portfolios. Some parents may not have that much financial wiggle room. "We have to let them know they're eroding their retirement [savings] sooner than they think if they pay at that rate."

With the estate tax set to expire at the end of 2010, calculating how much money parents can afford to give their children beyond the annual limit is complicated. Uncertainty about when and in what form the tax may be revived is a further difficulty. The issue, a political football, probably won't be resolved until a new Congress and a new President take office, says Jerry Chasen, an estate tax attorney in Miami. Because of the way inflation has increased the number of estates that are subject to taxes, he thinks the exemption will be set above $3.5 million, so that only the largest estates will be affected.