The end of the year often marks a time of giving, and many grandparents are considering the best ways to make financial gifts to their grandchildren. Whether for educational purposes, long-term financial growth, or setting the stage for a secure future, there are several avenues to consider that are both meaningful and financially advantageous.
UTMA accounts allow minors to own securities, including stocks, bonds, and mutual funds, under the custodianship of an adult until the child reaches the age of majority. This option allows grandparents to invest in a broad range of assets, providing potential growth over time while giving some flexibility in how the funds can be used for the child’s benefit. In 2023, the first $1,250 of investment earnings in an UTMA may be exempt from federal income tax, and the next $1,250 of investment earnings may be taxed at the child’s tax rate. Any excess earnings will be taxed at the parents’ tax rate. Donors should consider that the assets and control over these accounts must be transferred to the child by age 18 or 21, depending on the state, and can impact their eligibility for need based financial aid for college.
A grandparent could also fund a Roth IRA for minors who have earned income, which provides all the benefits of a regular Roth IRA, but is geared toward children under the age of 18. Roth IRAs offer tax-free growth and tax-free withdrawals in retirement, making them a powerful tool for long-term financial planning, especially when started early, due to the benefit of compound interest. A contribution to a custodial Roth IRA for a minor can be made if the child has earned income during the year. Activities like babysitting or mowing lawns can qualify the child for Roth IRA contributions. The current maximum annual contribution is the lesser of $6,500 or the total of a child’s earned income for the year.
One of the most powerful tools for education-focused gifting is the 529 plan. These state-sponsored investment accounts offer tax advantages when used for qualified educational expenses. Contributions to a 529 plan grow tax-free and withdrawals for qualified education expenses, such as tuition, books, and room and board, are also tax-exempt. Grandparents can set up an account and, in most states, also receive a state income tax deduction for contributions. For 2023, the contribution limit is equivalent to the gift tax annual exclusion amount of $17,000 per beneficiary, per grandparent. Donors also have the option to front-load 5 years of contributions – $85,000 (or $170K for 2 grandparents) per beneficiary. These gift limitation amounts double for married couples. Donors who max out this front-load 529 option will be ineligible to gift to the associated beneficiary for the four subsequent years, without dipping into their lifetime annual gift exemption amount.
Until now, when paying college costs from a grandparent-owned 529, it was necessary to account for college financial aid rules, as grandparents could hinder their grandchildren’s chances of receiving financial aid in certain circumstances. Thanks to the FAFSA Simplification Act, which is set to implement FAFSA changes for the upcoming 2024-2025 academic year, grandparents no longer need to worry about the “financial aid trap”. These long-anticipated changes make 529 plans an even more attractive tool for grandparents looking to aid their grandchildren with education funding while taking advantage of the tax and estate planning benefits.
Additionally, with the passage of the SECURE Act, it is now possible to use up to $10,000 from a 529 plan to repay qualified student loans per beneficiary, without incurring the typical 10% penalty. This provides additional flexibility for grandparents who might have excess funds in their 529 plans or who wish to use these funds to alleviate student loan debt of another grandchild or family member.
It is not too late to make impactful gifts before the end of the year. Contact Eagle Ridge to start the conversation on these or any other year-end gifting strategies.