We’ve written previously about various ways grandparents might want to structure the financial gifts they provide for their grandchildren. Grandparents may wish to include their grandchildren in their annual gifting plans as a regular part of their estate planning; in 2024, by combining their individual gift tax exclusions, a married couple filing jointly can gift as much as $36,000 to one or more individuals. For affluent individuals, annual gifting can provide a simple, yet effective tool for systematically reducing the size of the taxable estate while also providing valuable financial benefits for the coming generations.
But there’s certainly more to the picture for grandparents than simply providing the gift; depending on the specific needs and goals of your grandchildren, there may be ways to structure your giving that direct the benefits where they’re most helpful and effective. The way to begin thinking about this is to give careful consideration to what you want to achieve for your grandchildren. Should you prioritize funding education costs? Are you interested in providing them with a practical education on the benefits of long-term investing? Would you like to help them with the initial costs or a down payment on a first home? As with any important effort, defining your goals (and theirs) is the most important beginning point.
Let’s take a look at some major financial objectives that are likely to be important to your grandchildren and consider the tools that might be appropriate for accomplishing the job. Then, you may be in a better position to evaluate the most advantageous ways to direct your giving.
Education funding
As college costs continue to rise, more and more students are becoming dependent on outside help in some form to afford the cost of higher education. A 2022 report from the Fidelity investment group indicates that a growing percentage of parents believe help from grandparents will be necessary to cover education costs for their children. Not surprisingly, then, education funding may be near the top of your list for benefits you’d like to provide for your grandchildren. Fortunately, there are several good options to consider.
- 529 education savings plan: A 529 plan is a tax-advantaged investment account; deposited funds grow without federal income taxation. The funds can cover qualified K-12 tuition as well as college expenses. In 2024, individuals can contribute up to $18,000 ($36,000 for married couples) per beneficiary per year without incurring federal gift tax—a real advantage for those who need to reduce the size of the taxable estate as part of their estate planning strategy. Note that each state has its own tax treatment for in-state or out-of-state 529 plans. The flexibility of 529 plans is appealing; leftover funds can be transferred to another family member’s plan, used to pay down qualified student loan, or rolled over into a Roth IRA for the beneficiary.
- State-sponsored prepaid tuition plan: If you reside in one of the nine states offering a pre-paid tuition plan and your grandchild might attend an in-state college or university, this tax-advantaged account is an option. Currently, these states are Florida, Maryland, Massachusetts, Michigan, Mississippi, Nevada, Texas, Virginia, and Washington. The main advantage is paying tuition at current rates, with the plan investing those funds to cover tuition when your grandchild enters college. However, these plans can be less flexible than 529 plans, with potential limitations on qualifying expenses, contribution limits, resident requirements, and transferability.
- Private college 529 plan: Similar to a state pre-paid tuition plan, this allows you to tuition at today’s rates for future education costs at approximately 300 participating private colleges. Gains are tax-free, and some states offer tax deductions for contributions. If your grandchild doesn’t attend one of the private colleges, you can change the beneficiary or roll the funds into a state-sponsored 529 plan. Refunds are possible but adjusted for net investment returns, up to 2% per year.
- Coverdell education savings account (ESA): A Coverdell ESA differs from a 529 in that it covers only tuition for K–12 education, though allowing other expense categories for higher education. Contributions must end when the beneficiary reaches age 18 (unless they have special needs). In 2024, the annual contribution limit to a Coverdell ESA is $2,000 for individual with a modified adjusted gross income (MAGI) up to $95,000 (joint taxpayers up to $190,000); those with a MAGI of $110,000 (joint taxpayers $220,000) or more are ineligible to contribute. Contributions are not tax deductible, but beneficiaries receive tax-free distributions for qualified education expenses. Funds must be used or transferred to another beneficiary within 30 days after the designated beneficiary turns 30 (unless they have special needs). ESAs allow you to self-direct the investments and choose from a broader array of options.
Retirement Saving
But perhaps you have an even longer timeframe for the benefits you want to provide. Setting up a retirement account for a grandchild can be a great way to teach the benefits of time and compounding and also provide some hands-on experience with the ins and outs of the financial markets. Here, there are several good options, both tax-advantaged and otherwise.
- Custodial Roth IRA: Typically used for adult retirement savings, a Roth IRA can also be set up for an income-earning, taxpaying minor by an adult custodian and transferred to them upon reaching adulthood. Contributions are made with after-tax money, and gains are tax-free. In 2024, contributions can be up to $7,000 per year but cannot exceed the minor’s earnings. The potential growth from decades of compounding interest can significantly benefit your grandchild in retirement and possibly their heirs. For example, a single $2,000 investment today could grow to more than $93,803 in 50 years, assuming an 8% annual return. After five years, distributions up to $10,000 can be taken penalty-free and tax-free for major expenses like a home down payment or qualified education expenses. These assets do not affect federal financial aid eligibility for college.
- Custodial brokerage account: This account allows you to control the funds and investments until your grandchild typically turns 18 or 21, depending on the state, at which point the account is transferred to them. It’s a great option for teaching the fundamentals of investing. Anyone can make after-tax contributions, and there are no contribution limits, but the annual gift tax limit of $18,000 per person (for 2024) applies. Note that asset transfers into the account are irreversible. Unlike some accounts, there are no restrictions on the use and timing of fund distributions. However, the account assets are considered the beneficiary’s property, which could impact their eligibility for federal financial aid for college. Custodial brokerage accounts are not tax-advantaged. There are two types: Uniform Gifts to Minors Act (UGMA) and Uniform Transfer to Minors Act (UTMA). The main difference is that UGMA accounts hold financial assets, while UTMA accounts can hold both financial assets and property.
- Gifting Through a Taxable Brokerage Account: Another approach is for grandparents to open a taxable brokerage account in their own name, invest in a range of assets, and then gift the account or specific investments to their grandchildren once they reach an age or life milestone the grandparent deems appropriate. This method gives grandparents full control over the account during their lifetime, with flexibility in how and when to transfer assets, which can be advantageous for a variety of future needs. Unlike some tax-advantaged accounts, a taxable brokerage allows for broader investment options and fewer restrictions on fund use. This approach can empower grandchildren later in life, providing them with a significant financial gift while the account remains under the grandparent’s management until they’re ready to transfer it.
As you can see, there are various ways to provide a financial benefit to your grandchildren, depending on their most important priorities. At The Planning Center, we provide guidance to grandparents and others who want to make smart decisions about the gifts they provide. If you’ve got questions, we’d love to help you find the answers you need. Please contact us.
