Insights

August 15, 2023

Funding Graduate School by Gifting Appreciated Stock

In Financial Planning, Wealth Strategy

Katie Mietus
Contributions from: Katie Berntson, CFP®

If you have a student attending graduate school this fall, the tuition payment due date is quickly approaching! Clients who plan on funding all or a portion of the tuition for adult children or relatives often ask what the optimal funding method is – especially if other allocated savings, such as 529 College Savings Plans have already been depleted. The funding method that often makes the most sense is gifting appreciated stock holdings to the student directly.

Why? Because this strategy is tax-efficient for the donor and the recipient. By moving stock with large unrealized capital gains to the student, who is likely in a lower tax bracket compared to the donor, the student is able to realize those gains without being taxed at the highest bracket. The higher the embedded gain, the more effective this funding option will be by minimizing overall taxes between the two parties involved.

How It Works

Here are the steps to gift appreciated stock to a graduate student:

  1. Review your brokerage account(s) and identify stock that has appreciated in value.
  2. Determine the amount you would like to gift and select the holdings in your brokerage account that add-up to this gift amount AND have the highest percentage of gain embedded in the security (e.g., low original purchase price and a high selling price now).
  3. Establish an account in the student’s name for them to receive the gift.
  4. Instruct your student to sell the stock once it transfers to their account and use the proceeds to cover tuition costs.

Considerations

As mentioned, this strategy works by minimizing the overall taxes for the family. However, there are certain considerations to note before moving ahead with this gifting strategy.

Annual Gifting Exclusion Limit

Moving stock to an adult child’s investment account constitutes a gift for tax purposes. Each year, the IRS has an annual limit for which you do not need to report the gift on your annual tax return. In 2023, the annual exclusion is $17,000 per person. The following gifts are allowed without tax reporting:

  1. Each person may gift $17,000 to a single graduate student.
  2. Each couple may gift $34,000 to a single graduate student.
  3. Each couple may gift $68,000 to a graduate student and the student’s spouse.

The gifting dollar amount will be determined by the value of the securities on the day the stocks were transferred. If the gift is above annual gifting limits outlined above, a Form 709 (Gift Tax Form) must be filed with your tax return for the tax year the gift occurred. This typically incurs a small additional fee from your CPA. Any gift amount over the annual exclusion limit dips into your lifetime gift and estate tax exemption limit. There will only be tax due on a gift if you have exceeded the lifetime limit.

Dependency Status & Tax Rates

If your student is 24 years old or older (or 19 to 23 years old and not a full-time student) as of the end of the calendar year, they are likely in a lower tax bracket than you or the donor and will not be subject to the “Kiddie Tax” at your tax rates. In this case, the sale of the stock for tuition costs will net more to them after-tax and could actually be taxed at 0% if income is low enough.

Note: Be sure to check for any applicable state income taxes that may apply to determine if this strategy makes sense for you and consult with your CPA.

After-Tax Amount

With the sale of any stock or security in a taxable brokerage account, you will owe taxes on the gain (selling price less purchase price). The tax rate depends on:

  1. How long the investment was held (over or under 365 days).
  2. The seller’s ordinary income tax rate.
  3. Additional state taxes that may apply.

With a gift of appreciated stock, the original purchase price and date transfers to the recipient. If the security is held for more than 365 days, tax rates are more favorable for selling as they are considered long-term capital gains rates versus short-term or ordinary income rates.

Market Movement

As with all stocks, there is always the risk that the selling price could vary in value after the gift has been sent to your student. Thus, determining when to sell the stock is important. If the gift is intended to be used quickly for tuition costs, it is recommended to sell the securities as close to the date of the gift as possible. This will lock in the dollar amount needed and the proceeds may be added to a conservative and stable investment option instead. For example, if you sell the stock immediately after receiving the gift and add the proceeds to a high-yield savings account, the gift is no longer subject to stock market movements and will earn interest while waiting for the tuition bill.

Flexibility of Appreciated Stock

For a graduate student, gifting appreciated stock comes with more flexibility than traditional college savings vehicles like a 529 College Savings Plan.

The main benefit of funding 529 Plans is the long-term, tax-free growth. Certain states have tax benefits for contributing to a 529, but they can be limited. We recommend these accounts if there is a longer time horizon for the balance to compound and grow.

Funding a 529 enough to both cover college and graduate school may leave most with an overfunded 529. It’s difficult to determine from a young age if your child will go to college, let alone graduate school. There are restrictions for overfunded 529 Plans; funds can only be applied to qualifying expenses or transferred in only a few situations with no tax penalty. For this reason, it does not typically make sense to utilize 529s for graduate school. However, leftover funds from an appreciated stock gift may be used or saved without restrictions.

You may not transfer appreciated stock to 529 Plans as a contribution, as these accounts require cash contributions for funding. Selling stock to raise the amount necessary would incur capital gains taxes for the donor.

Moving Ahead

To navigate the nuances and determine if gifting appreciated stock to a graduate student in your life is a viable tuition-funding option, reach out to your Coldstream Wealth Management team.

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