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Transferring Ownership to Children
Parents and grandparents who are interested in learning how to issue preferred shares to kids want to know the legalities involved in children owning stocks. Preferred stock is defined by NPR.org as "A share in company that's a grade above over other classes of stock." Generally speaking, this means that preferred shares are paid a dividend before common shares.
Those who wish to issue preferred shares to kids may decide to transfer shares via the Uniform Gifts to Minors Act ("UGMA" valid only in South Carolina, Vermont, Guam or the Virgin Islands) or the Uniform Transfers to Minors Act (UTMA). Other options include creation of a trust or including the shares in a will to be tranferred equally to heirs upon death.
Parents, grandparents or other adults who issue preferred shares to kids generally are doing so to lower their tax burdens. Transfers to minors result in lower tax burdens for adults and depending on the income that is produced from the asset, little or no tax burden for the minor.
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Understanding Risks & Rewards of Gifting
To issue preferred shares to kids, parents may take advantage of gift tax laws that allow them to transfer specific amounts annually. However, it is important to understand that using the Uniform Transfer to Minors Act transfers the preferred shares to the minor irrevocably. Once this gift is made, the parent (or other adult) is holding that security in trust for the child. These funds may not be used by the adult at any time (except for "non-ordinary" expenses for the child) without severe penalties and possible legal repercussions.
Children do not have to use these funds towards their college education (unlike 529 accounts which are designated for college); although the funds may be considered when the child is applying for financial aid(1). In most instances, applications for college aid would require these assets be included in the assets reported on the application. In some cases, it may be required that at least twenty five percent of these funds be used towards college expenses.
Before a parent decides how to issue preferred shares to kids, they should first check with a financial planner to make sure that they are making the best possible decision. Transferring preferred shares to kids may appear to be a good idea from a tax standpoint, but if a young child turns out to be incapable of managing their own money as a young adult, it may not be the right decision.
Gift tax savings and probate savings may be good reasons to issue preferred shares to kids when they are young, however, before these decisions are made you should carefully weigh all of the options that are available to you.