Would you like to help boost the chances of financial success for your grandchildren? There are several savings and investment options you can establish and fund for them, while also teaching them about money management. Regardless of whether you’re among the Americans aged 50 and over with an average net worth exceeding $1 million, financial gifts to your grandkids can make ideal birthday present or achievement rewards.1 These gifts can create a lasting legacy for future generations and may also offer you tax benefits.
First, consider what you hope to achieve for your beneficiaries. Is minimizing their college education costs a priority? Do you want them to understand the potential rewards of long-term investing? Are you concerned they might struggle to save for a down payment on their first home? Defining your financial goals for your grandchildren will help guide you in selecting the right savings or investment options.
For example, if your main goal is to open an account and contribute funds that could grow significantly over your grandchild’s lifetime to help provide income in their retirement, a custodial Roth IRA (individual retirement account) might be the perfect solution. This account allows you to manage the funds, demonstrate how investments can compound over time, and offer access to tax-free money after five years. Conversely, if your focus is on covering your grandchild’s educational expenses, a tax-advantaged 529 education savings plan could be ideal. Although there are restrictions on how the money can be used, you can establish the account, manage the funds, and help pay for tuition tax-free.
Following are options for you to consider if you want to provide financial gifts and future savings for your grandchildren.
Education savings accounts
- 529 education savings plan: A 529 plan is a tax-advantaged investment account that allows you to grow contributions and investment earnings to pay for a beneficiary’s future qualified education expenses, federally tax-free. The funds can cover qualified K-12 tuition as well as college expenses. In 2024, individuals can contribute up to $18,000 ($36,000 for married couples) per beneficiary per year without incurring federal gift tax. Note that each state has its own tax treatment for in-state or out-of-state 529 plans. The flexibility of 529 plans is appealing; leftover funds can be transferred to another family member’s plan, used to pay down qualified student loans, or rolled over into a Roth IRA for the beneficiary.
- State-sponsored prepaid tuition plan: If you reside in one of the nine states offering a pre-paid tuition plan and your grandchild might attend an in-state college or university, this tax-advantaged account is an option. Currently, these states are Florida, Maryland, Massachusetts, Michigan, Mississippi, Nevada, Texas, Virginia, and Washington. The main advantage is paying tuition at current rates, with the plan investing those funds to cover tuition when your grandchild enters college. However, these plans can be less flexible than 529 plans, with potential limitations on qualifying expenses, contribution limits, resident requirements, and transferability.
- Private college 529 plan: Similar to a state pre-paid tuition plan, this allows you to invest money at today’s tuition rates for future education costs at approximately 300 participating private colleges. Gains are tax-free, and some states offer tax deductions for contributions. If your grandchild doesn’t attend one of the private colleges, you can change the beneficiary or roll the funds into a state-sponsored 529 plan. Refunds are possible but adjusted for net investment returns, up to 2% per year.2
- Coverdell education savings account (ESA): A Coverdell ESA mainly differs from a 529 in its coverage of qualified expenses and its contribution limits. It covers only K-12 tuition but allows broader expenses for higher education. Contributions must end when the beneficiary reaches age 18 (unless they have special needs). In 2024, the annual contribution limit to a Coverdell ESA is $2,000 for individual with a modified adjusted gross income (MAGI) up to $95,000 (joint taxpayers up to $190,000); those with a MAGI of $110,000 (joint taxpayers $220,000) or more are ineligible to contribute.3 Contributions are not tax deductible, but beneficiaries receive tax-free distributions for qualified education expenses. Funds must be used or transferred to another beneficiary within 30 days after the designated beneficiary turns 30 (unless they have special needs). ESAs allow you to self-direct the investments and choose from a broader array of options.
Investment accounts
- Custodial brokerage account: This account allows you to control the funds and investments until your grandchild typically turns 18 or 21, depending on the state, at which point the account is transferred to them. It’s a great option for teaching the fundamentals of investing. Anyone can make after-tax contributions, and there are no contribution limits, but the annual gift tax limit of $18,000 per person applies.5 Note that asset transfers into the account are irreversible. Unlike some accounts, there are no restrictions on the use and timing of fund distributions. However, the account assets are considered the beneficiary’s property, which could impact their eligibility for federal financial aid for college. Custodial brokerage accounts are not tax-advantaged. There are two types: Uniform Gifts to Minors Act (UGMA) and Uniform Transfer to Minors Act (UTMA). The main difference is that UGMA accounts hold financial assets, while UTMA accounts can hold both financial assets and property.
- Custodial Roth IRA: Typically used for adult retirement savings, a Roth IRA can also be set up for an income-earning, taxpaying minor by an adult custodian and transferred to them upon reaching adulthood. Contributions are made with after-tax money, and gains are tax-free. In 2024, contributions can be up to $6,000 per year but cannot exceed the minor’s earnings. The potential growth from decades of compounding interest can significantly benefit your grandchild in retirement and possibly their heirs. For example, a single $2,000 investment today could grow to more than $93,803 in 50 years, assuming an 8% annual return. After five years, distributions up to $10,000 can be taken penalty-free and tax-free for major expenses like a home down payment or qualified education expenses. These assets do not affect federal financial aid eligibility for college.
Savings accounts
- High-yield savings account: Prefer to keep it simple and easy? Consider opening a savings account at a bank for your grandchild. It’s low risk, given that the money doesn’t have the volatility of an investment account and is FDIC-insured up to $250,000. Contributions and withdrawals have no restrictions or income-related rules. A savings account is also liquid, providing easy and quick access to the money. The advantage of a high-yield savings account is the potential for higher earnings. For example, the annual percentage yield (APY) is 4.00% at Capital One (on Oct. 30, 2024) which is less than the potential annual return of the S&P 500 of 10.4% (since 1926).5,6
- Certificates of Deposit (CDs): For higher returns than a savings account, CDs are an option. They offer many of the same benefits as traditional savings accounts, but you must wait until the CD term ends to access the money. For comparison, Capital One offers an 11-month 360 CD at 4.50% APY (as of Oct. 30, 2024).
Choosing a gifting vehicle
With so many options available and various personal circumstances to consider – such as your financial goals for your grandchildren, their ages, and even their personalities – it can be daunting to decide which savings or investment vehicle is the right fit. Adding in the potential management time, effort, and tax consequences can make the choice truly overwhelming. That’s why we’re here to help.
Your Mercer Advisors wealth advisor can conduct a comprehensive review of your financial situation to assist you in identifying and selecting the goals you want to achieve, as well as developing a plan of action. We offer integrated expertise in financial planning, investment management, tax, estate, insurance, and more, all managed by a single team.
If you’re not a Mercer Advisors client and want assistance with choosing financial gifts for your grandchildren or want to learn the tax benefits of gifting, let’s talk.
- “Average net worth by age exceeds $1 million for Americans in their 50s,” USA Today, Apr. 1, 2024.
- Private College 529 Plan, CollegeWell, 2024.
- “Coverdell Education Savings Accounts (ESAs): How They Work,” Investopedia, Aug. 6, 2024.
- “Uniform Gifts to Minors Act (UGMA) Account: What Is It, How Does It Work,” Investopedia, Sept. 6, 2024.
- “Best High-Yield Savings Accounts Of November 2024,” CNBC, Oct. 30, 2024.
- “After a Rip-Roaring 2023, the Markets Are Taking a Breather,” The New York Times, Jan. 23, 2024.
