The first step will be deciding what type of financial assistance you would like to provide for your grandchildren.
Start by answering these questions:
- Do you want to help save for their education?
- Or would you prefer to set up a trust that they can access down the line?
- How much would you like to give a year?
- Will it exceed gift tax return limits?
EDUCATION
529 plans can be a wonderful way to save for your grandchild’s education, the money is secure and able to grow tax-deferred while earning interest.
The 2017 Tax Cuts and Jobs Act expanded 529s to also cover private school and qualified education-related expenses, which could be beneficial if your grandchildren are going to private schools. Unlike other types of plans, there are no mandatory withdrawals and can even be rolled over to a new beneficiary.
The plans also offer generous annual contribution limits. In 2019, individuals can donate up to $15,000 a year before triggering a gift tax.[i] If you are married, both you and your spouse could be contributing the maximum $15,000 each. If you have multiple grandchildren and children, you, and your spouse would be able to each give that amount annually and stay within the gift-tax exclusion. Some states also offer state tax benefits for contributions to a 529 plan. As always, review the state tax benefits with your financial advisor or tax advisor. The funds in a 529 plan grow tax-deferred and maybe tax-free as long as is the funds are withdrawn for qualified education-related expenses.
529 plans state that you must use the money for education. If a child decides not to pursue school, or the overall costs are less than what you have saved, there is a 10% penalty fee to withdraw funds for non-education-related expenses (with exceptions allowed if a child receives a scholarship). We consider 529 plans an excellent supplement to funding higher education, considering all the tax benefits, but we advise our clients not to overfund them.
It is important to consider the types of funds, diversification available in the plans, and the amount of plan fees, before deciding on opening an account. 529 plans may affect financial aid eligibility. When considering setting up a trust or custodial accounts for your grandchild, these types of accounts may also have an impact on financial aid. Always discuss these issues with a financial advisor or college financial aid specialist when considering how these accounts may impact any future aid.
TRUSTS
You may find that a trust is a better fit for your grandchild. Trusts allow you the flexibility to provide certain amounts of money for your grandchildren at certain ages, overseen by a trustee. You may stipulate in the trust that certain amounts of money are to be used for college expenses, or a down payment on a first home. While the trust offers a lot of flexibility in the use of funds, it does not come with the tax benefits of a 529 plan. Depending on how much money is in the trust, there may be some financial aid qualifications and tax impacts to consider.
The benefit of a trust is that there is more flexibility (vs. a 529 which is earmarked for education) and you can set terms on how the trust is used.
Trusts must be reported when applying for financial aid and they can affect need-based financial aid by 20% of the asset value.[ii] Discuss your options and concerns with your wealth management team on what type of trust or account would best for your personal situation, if funding your grandchildren’s education is important to you.
LOOKING TO THE FUTURE
Many couples don’t realize that they can use their wealth to create a legacy for their children and grandchildren. Ensuring that their future is financially secure is a wonderful gift. Trust funds and educational savings plans are not just a vehicle for the ultra-rich, but a valid option for anyone who wants to set a little aside for their grandchildren down the line.
[i] https://www.thebalance.com/how-is-the-gift-tax-calculated-3505674
[ii] https://twocents.lifehacker.com/should-you-open-a-529-or-a-trust-fund-for-your-kids-fut-1826193276
