Giving Love - and Money - to the Grandkids
In addition to being an incredibly loving gesture, paying for a grandchild’s education is a substantial investment in their future. We have thoughts about how you – and they – can get the most out of it.
1. 529 College Savings Plans
Contributions to 529 accounts grow on a tax-deferred basis, and withdrawals are tax-free if used to pay for qualified higher education expenses, including tuition, fees, room and board (on or off campus, including living at home for students attending school at least ½ time), books, supplies and equipment required for enrollment (computer equipment, internet services and software) and 24/7 meal plans. The 2017 tax reforms expanded qualified expenses to include up to $10,000 annually for K-12 tuition. Contributions to a 529 are treated as a gift to the beneficiary, but there are special rules that can allow you to give more.
Bonus for grandparents: While there are some limits on how much you can contribute to an account, there is no limit on who can contribute. If your children have set up an account for one of your grandkids, you can piggyback on that. In addition, account balances can be transferred to other students within the same family, so if one grandchild ends up not needing the full balance, you can move the money to someone else.
2. Custodial Investment Accounts
These special accounts set up for the benefit of younger children can make great gifting vehicles for grandparents. Custodial accounts are similar to a trust in that an adult custodian oversees the account until the child reaches either 18 or 21, depending on the particular state. At that point, the child gets full control of the funds.
There are two forms of custodial accounts: Uniform Gift to Minors Act (UGMA) and Uniform Transfer to Minors Act (UTMA). Most states follow the UTMA rules, South Carolina and the U.S. Territories continue to rely on the UGMA rules. A key difference is an UGMA account is limited to financial assets – like cash, stocks, and mutual funds – while an UTMA account can hold any form of property, including tangible goods and real estate. Assets deposited in either account immediately become the property of the child, so once it's set up, you can't change your mind about it. Unlike 529 plans, these accounts provide limited tax benefits (the first $1,100 in contributions is tax free, beyond that any income in the account is taxable to the child). The custodian of the account – whether that’s you as a grandparent or someone else – is permitted to disburse the funds prior to the child reaching adulthood for things ranging from the child’s tuition to them buying a new car.
Bonus for grandparents: Even though the assets are out of your hands as soon as you make your contribution, you can deposit more money into the account, up to $15,000 a year without incurring federal gift tax. That limit applies to each contributor, so two grandparents can give up to a total of $30,000 per year to a grandchild without owing any gift tax.
3. Cash-Value Life Insurance
A cash-value life insurance policy – which includes whole life, variable life, and universal life insurance – on the grandchild’s life can build into a strong asset over time. Beyond providing a death benefit, though, the policy can enable the child to take money out tax-free for any reason, including to pay for college (a nice bonus: the policy’s value is not included in financial aid calculations) or other significant life events, such as paying for a wedding or putting a down payment on a home. When properly structured, many of these types of policies allow for income tax-free withdrawals or loans from the cash value, and if the loan isn’t paid back, the death benefit is simply reduced.
Bonus for grandparents: Since you are the owner and decision-maker on the policy, you can determine when would be the most appropriate time to transfer full control and ownership to your grandchild. It may be when they reach a certain milestone or a significant life event. Regardless, this becomes a very nice, flexible gift for anyone starting to build a home or a family. Life insurance can sometimes be an expensive way to invest, however, so be sure to shop around for a cost-effective policy.
Which of these instruments would work best for you?
Our office can look at your financial situation and the type of help you wish to provide and help you sort out the options. No matter what you choose, your grandchildren will forever thank you.
Investors should consider the investment objectives, risks, charges and expenses associated with a 529 Plan before investing. This and other information is available in a Plan’s official statement. The official statement should be read carefully before investing.
Depending on your state of residence, there may be an in-state plan that provides tax and other benefits such as financial aid, scholarships and creditor protection that are not available through an out-of-state plan. Before investing in any state’s 529 plan, you should consult your tax advisor.
1Kassraie, Aaron. “Nearly All Grandparents Provide Money to Grandchildren”. AARP, April 12, 2019, www.aarp.org/home-family/friends-family/info-2019/grandparents-money.html