Your parents have likely worked hard to provide as good a life as possible for your family. As they watch the next generation grow and develop, they might want to share some of their good fortune with your kids, their grandchildren. Using their legacy to help their grandchildren get ahead in life can be rewarding for them, offer some financial relief for you, and prove to be a generous leg up for the next generation.
Whether helping to fund their college, contributing to the downpayment on their first home or simply providing financial confidence as they navigate life, investing for grandchildren can help bolster the entire family in the future—within their lifetimes and even after they are gone.
Having family conversations and coordinating with the grandparents can allow them to support their grandchildren in the best way for all involved in a way that matches all of your values and objectives.
Here are 5 smart ways to pass along money to grandchildren.
1. Education Savings Plans
A 529 College Savings Plan is a popular tax-advantaged way parents and grandparents can invest in a child’s education. It’s a great way to help students avoid loans that leave them starting adult life off in the red. The money can be used exclusively for qualifying education expenses, including tuition, books, supplies, and room and board, for a university education, accredited vocational training, or K-12 private school education.
With 529 plans, the IRS doesn’t set annual contribution limits, but rules vary by plan and by state, so you’ll need to do your research. Individual plans may set contribution limits, but the limit is typically high. Keep in mind that, for tax purposes, contributions are considered gifts that qualify for the annual gift tax exclusion. In 2022 the limit increased to $16,000 per individual contributor, per child. You also have the option to treat the contribution as if it were spread over a five-year period, and in 2021 may contribute up to $75,000, using a tax planning strategy known as superfunding. This only scratches the surface of what’s possible and what you should know, so we encourage you to work with a qualified tax advisor to determine the most tax-advantaged ways to give.
Rest assured that the person making the gift retains control of the investment decisions in the account. Each grandparent can set up a separate plan for each grandchild, keeping in mind that the funds are transferable to another beneficiary within your family if that child doesn’t have use for it. And if your children don’t use the money or you need it back for some reason, you have the option to reclaim it by paying a 10% penalty and taxes on any earnings.
If using a 529 to pay tuition, make sure to talk with a financial planner on how to use these assets to maximize financial aid eligibility when it is time for the grandchildren to go to college.
2. Prepaid Tuition Plans
Another way to support grandchildren’s education is through prepaid tuition plans. These plans are administered by the state and allow you to lock in tuition costs at today’s rates for any state public college or university. Essentially, you are purchasing college credits at the current price, and the grandchildren will cash in the credits when it comes time for them to attend a university. And any gains from this program are exempt from federal income tax.
In many cases, if a grandchild chooses to go to college out of state or attend a private university, the plan can still be beneficial as it allows them to receive and apply an amount equal to the average state school tuition upon enrollment at the time of the withdrawal.
You will want to look carefully at the fine print to check for guarantees of full tuition coverage and ensure you understand the details of your state’s plan.
3. Savings and Investment Accounts
It’s never too early to begin saving and investing for a grandchild. Begin with a high-yield savings account where cash gifts can grow into a sizable sum for years to come. Grandparents might enjoy watching the kids open up lots of toys now, but it may be even more appreciated down the line and more rewarding to know the accumulated money could be used towards their first car, wedding, or a downpayment on their first home.
Helping to fund a brokerage account, and educating them about it along the way, means you are not only exposing them to the power of financial literacy but you are providing opportunities for one of the foundational tenets of investing—long-term, compounding growth as the engine for wealth building.
Uniform Transfers to Minors Act/Uniform Gifts to Minors Act (UTMA/UGMA) accounts offer flexibility with few restrictions. Like education savings plans, you have the option to contribute up to $16,000 gift-tax free. You or an appointee would serve as the custodian on the account to oversee the administration until the child reaches the age of 18 or 21, depending on the state, at which point the child gets control of the account’s funds.
As soon as they get their first summer job as a teenager, you can also set up a tax-advantaged custodial retirement account for them. Funding an IRA for a grandchild from a young age or offering to match contributions they personally make will give them a head start that will pay off over a lifetime. With a Roth IRA in particular, contributions are taxed while returns are not, so they will potentially benefit from decades of investment growth.
4. Set up a Trust
One of the most common ways for grandparents to pass down wealth is through a trust. Despite ideas you may have about “trust fund kids” trusts are not only for the exceedingly wealthy; it’s simply a tool for passing along money to an heir or beneficiary.
With a trust, the funds remain controlled by a custodian until the child reaches the age of 18, 21, 25, or another age specified by the grantor. You can indicate that certain amounts are released in increments.
You’ll want to consider how the trust may affect your kids. It may limit their ability to receive financial aid in college, and if they receive a large sum at an early age, many young adults are not mature enough to use the money wisely. In many cases, it makes more sense for them to get larger distributions when they are older and more responsible.
5. Name Them as Beneficiaries
Grandparents may also want to consider making their grandchildren beneficiaries or contingent beneficiaries on their financial accounts. How to do this will depend on whether the grandchildren are adults or minors, but it may involve simply naming them as a beneficiary or it may involve also setting up a trust dictating how the funds will be distributed.
Whether they are selecting beneficiaries for your life insurance accounts, retirement accounts, or other investment accounts, naming grandchildren as beneficiaries means the money will pass to them without going through probate. It’s important to think carefully about how each beneficiary will be impacted by the money, meaning how they will be taxed, whether or not it will interfere with benefits they receive in the case of special needs individuals, and more.
Also, note that after the SECURE Act, naming minor grandchildren as beneficiaries may allow them to wait longer to take assets from an IRA account than if left directly to adult children.
The Gift of a Grandparent
Just as they are for you, your parents are also concerned for your children’s financial future and are often in the position to pass money on to them. That alone is a gift and they are fortunate to be able to do so. As they consider what they will provide for your kids and how their assets will be shared, they will also want to set them up for success. Work with them to teach your kids well and be sure to let them teach what they know or point them in the right direction to learn. Financial education is priceless.
Russell D. Rivera, CFA, CFP® is the Founder and President of Voice Wealth Management (Voice) in New York, NY. He also likes to think of himself as a Personal CFO and Financial “Therapist” for entrepreneurs, young professionals, and their families. He helps clients make prudent financial decisions regarding spending, saving, investing, and planning while giving a voice to the individual client's financial priorities and experiences.
The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual.
Investors should carefully consider investment objectives, risks, charges and expenses. This and other important information is contained in the fund prospectuses, summary prospectuses and 529 Product Program Description, which can be obtained from a financial professional and should be read carefully before investing. Depending on your state of residence, there may be an in-state plan that offers tax and other benefits which may include financial aid, scholarship funds, and protection from creditors.. Before investing in any state's 529 plan, investors should consult a tax professional. If withdrawals from 529 plans are used for purposes other than qualified education, the earnings will be subject to a 10% federal tax penalty in addition to federal and, if applicable, state income tax.
This material was prepared by Crystal Marketing Solutions, LLC, and does not necessarily represent the views of the presenting party, nor their affiliates. This information has been derived from sources believed to be accurate and is intended merely for educational purposes, not as advice.