For many grandparents, spoiling their grandchildren is one of the perks of being part of the older generation. But spoiling isn't just about sweets and snuggles.
Grandparents are financially generous, spending an average of $2,383 annually on their grandchildren, according to a survey by AARP.
While toys, clothes and entertainment top the list of ways grandparents spend money on their grandkids, 27 percent of grandparents contribute to school expenditures and 19 percent contribute to college savings.
Paul DeLauro, manager of wealth planning for City National Bank, said that's not surprising. The excitement of becoming a grandparent brings with it a sense of responsibility about ensuring the grandkids are raised to be successful and productive individuals with the right values.
“A great role for grandparents can be to teach their grandkids about money; about what it takes to make money and about what it takes to save money," she said.
With grandparents becoming increasingly involved in their grandchildren's lives, providing financial support can also be an opportunity for transferring financial values and know-how.
The first financial step many grandparents consider is to set up a fund to pay for college expenses for their grandchildren. Tuition at the most expensive colleges costs between $50,000 and $60,000 annually and, according to projections, four years at a private college could cost $487,004 by 2035.
“Establishing a 529 plan for college funds is a tax-efficient way for grandparents to support their grandkids," said Kerry Michael Finn, a senior trust advisor with City National Bank. “An individual can put up to $15,000 in a 529 without incurring a gift tax and a couple can give $30,000."
While you can do an annual gift, some grandparents also like to do a one-time, five-year gift of up to $75,000 for an individual or $150,000 for a couple.
“Frontloading the college fund with a five-year gift gives the money a longer time to grow," said Finn. “It's essentially just prepaying the gift and it means any additional gift money you want to give would be taxable. After the five-year period, you can begin giving again up to the one-year gift tax exclusion each year."
While the parents or the grandparents can open a 529 plan or both can open separate plans, there are some advantages and disadvantages to those choices.
“I suggest that the grandparents ask the parents to open a 529 plan that the grandparents can contribute to," said Finn. “But some grandparents want to control the money, particularly if they don't trust the parents to be good stewards of the funds."
The assets in a 529 plan belong to the owners — the parents or grandparents —not the recipients - the grandchildren. This means that the account owners can access the funds for other purposes if they wish, although they will pay a tax penalty if they do so.
“One important difference is the way the 529 funds are viewed when the grandchild applies for financial aid," said DeLauro. “If the parents own the account, it counts as a parental asset, but if the grandparents own the account, any distribution counts as income for the grandchild. That could significantly reduce the financial aid they receive."
For wealthy families, of course, qualifying for financial aid is less likely to be a concern.
One downside of a 529 plan is that it is strictly limited to use for education purposes.
“Some people decide not to go to college, which can be a problem if you've set up a substantial 529 plan," said DeLauro. “You pay a tax penalty if the funds are used for something other than education. The only option to avoid that is to change the beneficiary to another grandchild who might go to college."
Another option for grandparents is to pay their grandchild's tuition directly to the university. That removes any concern about gift taxes and about the parents or children using the money for something other than college, said DeLauro.
For families with children with special needs, an ABLE account functions in a similar way to a 529 plan, said Finn.
“An ABLE account is a tax-advantaged account that can be used to pay for any type of services that help someone with special needs," said Finn. “The funds are tax-free when they're pulled out of the account."
Grandparents can also choose to give money directly to their grandchildren to be used for any purpose through a Uniform Gift to Minors Account (UGMA) or a Uniform Transfer to Minors Account (UTMA). You can transfer any amount of money or other assets into these accounts, but the gift will be taxable if you go above the gift tax exclusion amount of $15,000 per individual or $30,000 per couple.
“The good news is that these accounts are flexible and can be used for anything, and that they're under the control of the grandparents," said DeLauro. “The bad news is that once the child reaches the age of majority, which depends on their state, the money is theirs and they can do anything they want with it."
To provide for their future without the risk of irresponsible youthful spending, grandparents can contribute to an IRA or a Roth IRA for their grandchildren, said Finn.
“The grandchild has to be 16 and has to be working, but the advantage is that the money can't be touched until they retire without incurring a tax penalty," said Finn. “That's a big incentive to keep the money in place and provides a long runway for the money to grow."
Grandparents are limited to the annual gift exclusion amount of $15,000 per individual or $30,000 per couple for IRA contributions.
A popular long-term solution for the transfer of multigenerational wealth is a trust, which can be established to match parameters set by the grandparents. A trust removes assets from the grandparents' estate and yet allows them to keep control over the assets.
“You can establish a trust for your kids and then another trust for all of your grandchildren," said Finn. “Or you can set up a trust for each branch of your family, such as one for your daughter and her children, and another for your son and his children. Or you can open a trust for each child separately. A trust is just a container, so you have to decide on your goal and determine the best way to manage that."
For example, one of Finn's clients established a “HEET" – a health and education exclusion trust – for his grandchildren, funded with $1 million.
“The trust will pay for college up to a certain amount of money, but the kids have to submit their grades and proof of attendance," said Finn. “The trust can be used for health issues, too."
While some grandparents fund a trust with the only stipulation that the funds be available to their grandchildren when they turn 18, 20 or 25, Finn cautions against this approach.
“It's not always wise for young people to receive a large amount of money," he said. “I recommend giving them a piece of the trust at a time or control over a piece, such as receiving 25 percent of the trust at age 25, another 25 percent at 35 and the rest at age 45."
Another possibility is for the grandchild to be named as co-trustee at age 30, said Finn.
“That way the other co-trustee keeps some control so the assets are protected and the grandchild can't just pull out funds willy-nilly," said Finn. “You can also mitigate risk this way. For instance, if the grandchild gets in a car accident at age 30, he can resign as co-trustee so that the assets aren't his and they're protected in a lawsuit."
Before making any contributions to your grandchildren, you first need to evaluate your finances.
DeLauro warned that even if you have the financial means to spoil your grandchildren, you need to have a comprehensive financial plan in place before giving them any money.
“Even families with lots of wealth sometimes have assets but not enough liquidity for cash flow," said DeLauro. “Have a financial planner make sure you are protecting yourself, your spouse and your children, and then you can start to look for ways to take care of your grandchildren."
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