Here's what else you need to know about if you have the wherewithal to start your children off with a bang, its useful to know that you can give as much as $13,000 a year to each child (indeed, to as many individuals as you want) without any tax consequences to you.
SEE ALSO: Kids and Money
So you and your spouse can give a total of $26,000 annually to your children, grandchildren, stepchildren or anyone else. (If you exceed the annual limit, you'll need to file a federal gift tax return but it's highly unlikely you'll actually have to pay any tax on the gift.)
A good vehicle for such a gift to a child is a custodial account opened under the Uniform Transfer to Minors Act (UTMA) or the Uniform Gifts to Minors Act (UGMA).
To open one of these accounts, simply tell a bank, brokerage or mutual fund company that you want to do it. You'll get a standard form to fill out. An adult must be appointed to act as the custodian of the account -- this could be you, your spouse, or a trusted friend or relative.
Here's what else you need to know about custodial accounts:
-- The custodian has the power to invest and withdraw funds for the benefit of the child, but the money can't be used to pay for items considered support obligations of the parents. Any income used for the child's support could be counted as taxable income to the parents.
-- Income earned by the account will be taxed to the child, but see the discussion below about the "kiddie tax."
-- Once the child reaches the age of majority -- usually 18 or 21 -- he or she gets full control of the money in the account.
-- Your gift is irrevocable. You can't legally take it back under any circumstances, even if you run into financial difficulty.
-- The gift may haunt your estate. If you are both donor and custodian, and you die before the child reaches majority, your gift would be considered part of your estate for federal tax purposes. For the vast majority of people, that doesn't matter, since their estates are not large enough to be targeted by the federal estate tax. If your estate is worth millions, though, this is an argument for appointing someone other than yourself as custodian.
Setting up a trust is a way to leave money to your children while controlling how it is to be invested, spent and distributed to them. Testamentary trusts take effect upon your death and can be changed or withdrawn while you're still alive. A revocable living trust is in effect while you're alive.
A irrevocable trust allows you transfer the ownership of property perhaps creating income and estate tax advantages -- but maintain control in the meantime. You choose the trustee and specify what happens to the money placed in the trust.
Unlike in custodial accounts, money held in trust needn't be transferred to the beneficiary at any specific age. You can choose to turn over all of it when your child reaches 21 or spread out payments over the child's adult life.
For any account you open for your child, use the child's social security number as the tax identification number. This will ensure that the interest will be taxed to the child.
To prevent parents from giving assets to children to reduce their own tax bill, Congress created a set of rules known as the "kiddie tax." Here's how it works for 2010: The first $950 of investment income (interest and dividends, for example) is tax-free to children. The next $950 is taxed at the child's rate -- presumably 10%, which is the lowest tax bracket. Investment income over $1,900 earned by a child is taxed at the parents' presumably higher rate (as high as 35% in2010).
When the kiddie tax was created, it disappeared when a child turned age 14. But over the years, Congress has ratcheted the age upward. For 2010, the kiddie tax also applies to children who are under age 19 and to full-time students between the ages of 19 and 23 (unless they earn enough from a job to cover more than half of the cost of their support).