How to Save Money for Your Kids & Grandkids
Young adults start out in life at their lowest earning potential just when they need to set up their lives.
Grandparents, on the other hand, are usually at a point where their expenses are declining or have plateaued, often when their financial resources are at their peak.
And so it makes perfect sense that grandparents would look for ways to help ease their grandchildren’s financial burdens. Naturally, it’s good to start as early as possible.
Here are a few ways grandparents can translate their loving thoughts into meaningful help for their grandkids at an important time in their lives:
1. Savings Accounts
A savings account is one of the easiest and most flexible ways to set money aside for grandchildren.
Unfortunately, savings accounts at the big banks offer unattractive yields. To earn as much as possible on these deposits, it is important to search for the top-yielding savings accounts.
Fortunately, there are several tools that can help you find the best savings account interest rates.
You have the option to keep the savings account in your own name, or open it in the name of a grandchild. Whoever is named on the account as the owner will be liable for income taxes on interest earned but will also have control over the use of the account.
Which Banks Have the Best Savings Account Rates?
Finding the bank with the best savings account shouldn’t take a lot of work. The banks featured below offer above-average interest rates on their savings accounts.
2. Money Market Accounts
Money market accounts are similar to savings accounts, but they usually offer higher interest rates and may sometimes require higher deposits. However, that is not always the case and, once again, it’s prudent to compare the best money market accounts for yields and requirements.
3. Trusts
Trusts, of which there are several different types, are arguably the most flexible ways grandparents can transfer assets to their grandchildren.
Trusts can be set up at any age but remain in the grandparent’s name. That means they are not included in a grandchild’s financial aid application’s means test and the grandparents retain control over how and when assets can be used.
However, setting up a trust can be expensive – up to $5,000, according to experts. Therefore, using a trust usually benefits grandparents with the means and desire to transfer substantial amounts to their grandchildren. It also carries estate tax benefits.
As a general rule of thumb, trusts tend to be attractive only if the amount of transfer contemplated exceeds $25,000.
4. UTMAs/UGMAs
The Uniform Gifts to Minors Act (UGMA) and Uniform Transfer to Minors Act (UTMA) allow grandparents to give or transfer money to minors without having to set up a trust. These types of accounts are relatively easy to set up and they allow funds to be invested in many types of assets, such as mutual funds, stocks and bonds.
A downside to this type of account is it’s a one-way street – once you give money using a UGMA or UTMA, you can’t take it back. Another is that the money is held in the name of the grandchild, where it may count against them in a college financial aid application, or they may withdraw it and use it for purposes the grandparent did not have in mind.
5. College Funds
529 Plans
The federal tax code offers two types of 529 plans that give grandparents a tax-advantaged way to set aside college funds for grandchildren. In short, they are a means to pay today for a college education later.
The first type of 529 plan is a savings plan, and the second is a prepaid tuition plan. Both allow after-tax contributions (in other words no tax deduction) – but all growth and withdrawals are not taxed, provided the funds are used for education purposes.
The annual limit on contributions changes from year to year, and for the 2019 tax year is $30,000 for a couple or $15,000 for an individual, with a lifetime contribution cap of $250,000 to $300,000, depending on the state.
Although the tax aspect is federal, 529 plans are operated by states or state agencies. A complete history and more details of 529 plans can be found at CSPN, an organization formed by all states as a clearinghouse for information.
Not all states offer both 529-plan types (savings and prepaid tuition), so make sure to check your state’s regulations. 529 plans cover most two- and four-year colleges and universities, U.S. vocational/technical schools, and certain eligible foreign institutions.
Prepaid tuition plans offer a way to inflation-proof the cost of your grandchild’s higher education, and is usually guaranteed by the state. For instance, if a grandparent purchases a year’s tuition at a state college, that purchase will always be worth a year’s tuition, even if tuition rates may have doubled a decade later.
College savings plans do not lock in tuition rates and don’t guarantee which costs are covered, which make them less onerous for the states. (It’s no surprise that almost all states offer 529 college savings plans, but only 17 offer prepaid tuition plans.)
There are restrictions on what a 529 plan can invest in, and these vary by state. So it’s important to learn your states’ options. You can invest in any state’s 529 plan, regardless of your state of residence. However, you may find your state offers some incentives if you invest there.
A significant benefit of 529 plans is they usually don’t have an adverse impact on the grandchildren’s application for financial aid.
Coverdell
Coverdell Education Savings Accounts (ESA) operate like a Roth IRA for retirement: They allow you to invest post-tax earnings in a fund designated for education expenses. Interest or other income earned on those investments are not taxed. The downside is the limit: $2,000 per student under 18 per year.
The benefit of Coverdell ESA accounts is their flexibility — you can invest more things than you can in 529 accounts (see below).
There is also an income limit. Once a family earns $220,000 per year (or $110,000 per year for a single parent) the amount you can contribute goes down.
6. Savings Bonds
Savings bonds are purchased directly from the U.S. Department of the Treasury. There are various kinds of savings bonds, with different interest rates and restrictions. Some allow tax relief when the proceeds of redemption are used for education at qualified institutions.
What to Decide before Investing for Grandchildren
Before opening a savings account or other investment, you will need to decide:
Your goal
Do you just want to help your grandchildren get set up in life or do you want to direct your gift into a specific direction, like college tuition, a trip abroad, etc.? The answer could determine which types of investments to pursue.
Who owns the funds?
You can elect to keep a savings account in the grandparent’s name or set it up in the grandchild’s name. However, if the grandchild owns the funds, that could adversely affect their application for financial aid. Many aid programs use formulas to calculate the applicant’s financial status, and financial assets (like savings accounts) have to be included.
Trusts and 529 plans avoid the issue, because the grandparent stays in control of the funds.
Access to the funds
Once the grandchildren reach a certain age, they will be able to withdraw any monies in their name and use it in ways the grandparents might not have intended. Many states allow children to freely access any funds in their names once they reach 18 or 21.
Grandparents can set up savings accounts in their name and add the grandchildren as beneficiaries. This allows them to maintain control of the investments and specify where it goes when they pass away.
Frequently Asked Questions
Q: I’m starting to put aside some money on my grandson’s behalf for future needs such as education. What are some safe and appropriate things to do with that money as it builds?
A: Oddly enough, “safe” and “appropriate” may be two different things in this instance.
To be completely safe, FDIC-insured savings accounts and money market accounts would be the way to go. Normally, you could add CDs to that list, but since the best CD rates require the longest lock-up periods, they may not be the best choice when interest rates are so abnormally low. A return to normal inflation later would mean even the highest CD rates today would lose purchasing power.
The reason “appropriate” might be different from “safe” in this instance is that, with a long time horizon in mind, you might consider some more aggressive investments, such as stocks. Assuming the education needs you refer to are for college (as opposed to private school at an earlier stage), you’re looking at 16 years or so before your grandson will start needing to access the money.
With that long a time frame, it is perfectly appropriate to invest in stocks, at least to some degree. While stocks won’t be completely safe, they do typically provide more protection against inflation than deposit accounts.
Perhaps the best course is to start slowly. Shop for savings accounts or money market accounts, and find the best savings or money market rates you can. Then, as this account starts to build, you can consider investing some of that money in a diversified stock fund. Look for a fund with reasonable fees, and which has done well over a period of both rising and falling stock prices. This will give you some balance between safety and growth, and that’s a sensible way to build for the long term.
