From the moment your grandchildren are born through the thrill of watching them grow up, while your first instinct is to hug and kiss, a close second may be to do whatever you can to give them a financial head start in life.
“That’s what comes up right away when we do financial planning with a newly minted grandparent,” says William Shad, Head of UBS' Wealth Planning and Trust Consulting USA based in Wellesley, MA.
One of the simplest and most effective ways to build substantial funds for a grandchild’s long-term needs is to use the annual gift tax exclusion. For 2019, you can give up to $15,000 ($30,000 for married couples) to as many people as you like without paying tax.
Grandparents might put those gifts into a custodial investment account, established under the Uniform Gifts (or Transfers) to Minors Act—usually known as UGMAs or UTMAs. Yet this approach has a serious drawback: Depending on the type of account you use, when your grandchild reaches age 18 or 21 (whichever is the age of majority in their state), he or she gets immediate access to those assets—whether they’re prepared to make good financial decisions or not.
“You may want to put a little money into custodial accounts, so they’ll have a small nest egg when they go off to college, but don’t overdo it,” Shad suggests. If you want to exercise a bit more control over how the money is used, there are other options to consider, Shad says. Be sure to speak with an attorney or your accountant or other tax advisor about your options.
Consider opening a 529 education savings plan
State-sponsored 529 plans are popular for good reason. You could create one for each grandchild, using your own and your spouse’s annual exclusion to fund it each year. Investment earnings in the account aren’t taxed, and distributions to pay the beneficiary’s college expenses are also tax free. And, unlike with UGMAs and UTMAs, you control the account and funds can only be used for higher education. Currently, contributions are deductible from state income tax in over 30 states.
A 529 plan allows you to make annual contributions of up to $15,000, or $30,000 with your spouse (the federal gift tax annual exclusion for 2018). To get a head start on education savings, 529s also allow you to contribute the first five years of savings up front—so, $75,000, or $150,000 with your spouse. Then, five years later, you can make another accelerated payment. “This is one of the easiest ways to get ‘chunks’ of tax-free gifts out of your estate,” Shad says.
In addition to college expenses, 529 assets can now be used to pay for up to $10,000 of tuition for K-12 education, thanks to changes in the Tax Cuts and Jobs Act.
Pay college costs directly
But a 529 plan works best if established when your grandchild is young, so the assets have time to grow. For teenagers soon to start college, you might consider writing a check for the student’s tuition directly to the university—the tuition won’t count toward your annual gift exclusion, so it offers a great way to move money from your estate without incurring taxes. Certain room and board costs (above the school’s “cost of attendance”) don’t have the same exclusion, so you might instead use gift money to cover these additional expenses.
Start a Roth IRA
Your teenage grandkids almost certainly aren’t thinking about retirement. Still, if they earn money at a summer job, for example, they’re eligible to contribute their earnings to a Roth IRA. Investment earnings in the account can compound tax free for many decades until withdrawn—also untaxed—during retirement. You can give minor grandkids a jump on saving by establishing and using some of the annual exclusion gift to fund it for them. The annual contribution can’t exceed the amount that they earned and is capped at $6,000 for 2019.
Put your gifts in trust
A way to avoid tempting grandchildren with too much cash too early is to establish one or more trusts naming them as beneficiaries. “This is a great way to keep assets protected,” says Shad, not only from the kids’ spending the money but also from others—for instance, a divorcing spouse or a judgment in a lawsuit.
Or you could use what is sometimes called a “family bank model”—a trust created to benefit several members of the younger generations. Access to assets, controlled by an independent institutional trustee or an individual you’ve appointed, could be based on certain life events, such as having a baby. Someone who wants to start a business could ask the trustee for a loan, says Shad. A benefit to this structure, he notes, is that it could continue to help those in future generations—helping a great-grandchild, for example.
Share your wealth—and your information
Your Financial Advisor can help you decide how you want to support your grandchildren, using these or other approaches to provide maximum benefits for the grandkids while also reducing the size of your taxable estate.
Whatever strategy you choose, be sure that you have enough funds to cover your own needs for a long retirement, Shad advises. Then, as a final step in this planning process, your Financial Advisor can help organize a family forum with your children—perhaps the grandchildren themselves—and any other family advisors you want to include.
“We present the findings of our analysis to the whole family,” Shad says. This helps put everyone on the same page, and reaches across the generations with information as well as money. Says Shad, “For many families, that’s an irresistible combination.”