Becoming a grandparent is a major milestone for many. We often hear clients describe the incredible joy that they experience holding their grandchild for the first time. Whether you’re a rookie grandparent, or a seasoned pro, you’re most likely considering taking a new direction and setting new goals with respect to your estate plan. Perhaps you want to put money aside to help pay for your grandchild’s school directly, contribute to a 529 Plan, or you may want to plan more long-term to ensure that your grandchild benefits from your estate after your death.
Whatever direction you wish to take in planning for your grandchildren’s financial future, below are five avenues you may wish to take so you can reach your goal:
1. Set up a 529 Plan
These types of plans have gained popularity over the last few years. A 529 Plan allows you to fund a plan for your grandchild’s educational benefit. Earnings aren’t taxed if used for qualified expenses such tuition, fees, books and room and board. Currently, you can gift up to $16,000 per year into the account, although the IRS allows you to make a one-time contribution up to $80,000 to a 529 Plan tax-free by treating it as if you had put in the money over five years.
There are some downsides to these types of plans, however. While setting up a 529 Plan in your grandchild’s name allows you to decide how the money will be invested and when it will be distributed, it can have a negative impact on the student with respect to financial aid. Once the money is distributed, it is considered student income. Contributing to a 529 Plan that the parent owns is considered a parental asset when calculating the Expected Family Contribution for federal financial aid purposes. Those contributions count for up to 5.64% of assets versus 20% for student-owned assets.
2. Set up Custodial Accounts
Established under the Uniform Gifts to Minors Act (UGMA) and often referred to as Uniform Transfer to Minor Accounts (UTMA), these types of accounts are often used by grandparents to give money to a grandchild. This type of account ensures that an adult “custodian” continues to control the account until the child reaches the age of majority. Money is put into this account on an after-tax basis, meaning that taxes have already been paid on the money by the grandparent prior to funding. While the grandchild cannot personally access the account until he or she has reached the age of 21, the money can be used for the child’s benefit as directed by the account’s custodian (usually the child’s parent or the grandparent themselves). One thing to remember: taxes on any income earned by the account are the responsibility of the minor and taxed at their rate, not yours.
There are some disadvantages Custodial Accounts. First, if the child might otherwise qualify for financial aid, money in the UTMA account could reduce the amount of aid that they might receive. Additionally, the full value of these accounts becomes available without limitation to the child when they turn 21 years of age, in most states. Finally, gifts made to these accounts are irrevocable, meaning you cannot change your mind and claim the money back.
3. Set up a Grandparent Asset Protection Trust
Setting up a trust is a common way for a grandparent to provide for their grandchildren. A trust will ensure that someone is managing the money and making decisions about its use while the grandchildren are still young. In fact, the Grandparent Asset Protection Trust allows you to decide at what age or ages your grandchildren can access the money, and put limitations, if you so choose on the use of the money. Some money limitation examples include instructing the money to be used for college expenses, matching part of a first salary for retirement savings, or supporting a new parent who takes time away from work. The trust can be structured to ensure that the grandchild doesn’t get a large distribution until the Trustee feels they are mature enough to be responsible with respect to its management.
4. Fund a Roth IRA
Because there is no minimum age for setting up a Roth IRA, a grandparent can open a custodial Roth IRA at any financial institution that offers them. With this type of investment vehicle, the grandparent maintains control of the account until the grandchild becomes the age of majority (age 18 or 21, depending on your state). Because of the tax-sheltered growth and future tax-free qualified distributions, they offer, Roth IRAs are a popular choice.
Remember, however, there are limitations to the contributions that can be made to a Roth IRA. For instance, the child must have received compensation during the year in order for a contribution to be made. Compensation includes hourly wages, salary and self-employment income. Additionally, there are contribution limitations—in 2022, for those under age 50, the total contribution limitation is the lesser of $6,000, or the total of earned income for the year.
5. Share Financial Lessons and Values
Whatever mechanism you choose, gifting to your grandchildren can be a wonderful opportunity for you to share your own values. Just hearing about your life story and how you handled “tough” times will help your grandchild learn valuable lessons about adversity and the value of endurance and resilience. You can also use the opportunity to discuss the value of “giving back”. Maybe you and your grandchild share a passion about the same special cause like the wellbeing of pets and animals. Discuss with your grandchild occasions you could spend together to help at a local animal shelter. Use this quality time to talk to them about the value of charitable giving and help them set and reach their own financial goals.
And of course, make sure that you are financially secure yourself before embarking on any gifting strategy for the benefit of others. Many studies note that grandparents tend to overextend their financial support when it comes to family members in needs. Make sure that you can provide for your own financial needs and goals first before moving forward with providing gifts to others.
