Grandparents characteristically love to spoil their grandchildren. But many want to do more than just lavish them with birthday presents and ice cream.
They want to give something substantial, like a large chunk of change or the opportunity to go to college, but may not know the best vehicle for doing so.
We consulted several financial planning experts to get a better understanding of which giving options provide the biggest impact at the lowest cost.
Contribute to a 529 plan
A 529 plan is a state-sponsored qualified tuition plan that allows anyone to set up a college fund in a child’s name.
Why are 529s so popular? According to estate attorney Amy S. Holmes, Esq., it’s because “the grandparent can maintain control over the funds, the proceeds grow tax-free and avoid all tax if withdrawn for qualified higher education expenses, they make a minimal dent in any financial aid package [if owned by the grandparent] and they offer very high lifetime contribution limits—in some states as much as $250,000 to $300,000.”
However, she notes that contributions are subject to the gift tax if they go above $14,000 (for individuals) or $28,000 (for couples) annually.
Also read: Everything you need to know about 529 college savings plans
So what are the downsides? Any money taken out of a 529 plan that is used for a non-education expense will incur a 10% penalty on plan earnings, as well as federal income taxes and in some cases, state taxes on the funds. There are some exceptions, such as if the student receives a scholarship.
Pay for school expenses directly
According to retirement specialist Richard E. Reyes, CFP, and coach at The Financial Quarterback, it’s important to remember that not all kids go to college, so depending on the circumstances, paying for school expenses directly may be a better option.
“I am always somewhat apprehensive when grandparents want to concentrate too heavily on college funding,” he says.
If setting up a 529 feels too risky, you can offer to pay for educational costs when and if they arise, Holmes offers. Simply set up a dedicated savings account in your own name that you can draw from as needed for these expenses.
As long as you make payments for a student’s tuition and fees directly to the educational institution, rather than to the student or their parents, these amounts do not count toward your federal gift tax exemption limits, she says.
Set up a trust fund
Trusts are another option for grandparents looking to gift large sums of money.
“Setting up a trust for a grandchild can reduce your taxable estate and [help you] maintain a very high level of control over how and when the funds are used,” Holmes says. “However, creating and maintaining trusts [can be] costly, so [I’d only recommend them] for someone moving larger sums of money, typically $25,000 or more.”
Certified financial planner Andrew McFadden, principle at Panoramic Financial Advice, agrees, noting that trusts set up by a professional are expensive, with costs typically ranging anywhere from $1,500 to $5,000.
“But when you’re talking about large chunks of cash, you want to make sure your grandkids are using it in a responsible fashion,” he says. “The only way to do that is to limit the use, and give it to them at ages where they have plenty of financial experience.”
Talk to your financial adviser about setting up a trust that can utilize the generation-skipping transfer tax exclusion. This exclusion will allow you to leave money directly to your grandchildren, (essentially ‘skipping’ your children,) without incurring an estate tax, as long as the amount is less than $5.49 million.
Open a UTMA account
Another type of trust is a Uniform Transfer to Minors Act account, a custodial account that provides a way for those under 18 to own assets, such as securities.
“UTMA accounts can be a useful option for those wishing to make smaller gifts, and there are no limits on the amount you can contribute, although the gift tax threshold amounts — $14,000 to $28,000 in 2016 — should still be considered,” Holmes says. “A potential drawback is that these accounts [are often] tied to the market, so they can gain or lose money depending on market fluctuations.”
Other points to consider, she says, is that the grandparent may not want the child’s adult parent involved in the gift, which is a necessity with these accounts; and that the child would automatically get the money once he or she turns 18 (or 21 or 25, depending on state law), a precarious age for receiving a large sum.
Invest in a Roth IRA
If you’re a bit late to the game, your grandchildren are out of college, or you don’t have a lot of cash to give, you still have a great option for gifting money with a Roth IRA, which can be set up once a grandchild is in the workforce.
“Roth IRAs are attractive to some because the funds can be used for anything, not just retirement,” Holmes explains. “While the grandparent cannot set up the Roth IRA directly, she can help a grandchild set one up and can invest in or match the grandchild’s contributions.”
Additionally, doing this can provide a teachable moment about saving for the future or learning about the stock market.
Name the child on your life insurance
This option sounds like an easy one, since you won’t need to do anything except name a child as your beneficiary, but it’s not typically the best way to gift money. First of all, life insurance companies don’t pay out cash directly to minors, so if your grandkids are under 18 (or age of majority, which vary by state), there would need to be a court-appointed guardian to manage the money for a minor to receive it.
“From a tax perspective, it is also more advantageous to gift money to a grandchild during your lifetime because doing so reduces your taxable estate, thereby creating tax savings for your ultimate beneficiaries,” Holmes explains.
While life insurance is helpful for ensuring that your spouse can live comfortably after you die, it’s not the best choice for gifting, given the more efficient and money-savings options available.
With these options in mind, you can make a wise decision about how to gift money to your grandkids, while potentially giving yourself a tax break to boot. Discuss your choices with a trusted financial planner so you can tailor a trust or college account to your specific needs and money situation.
That way, you — and your beneficiaries — can get the most bang for your buck.