The holidays are just around the corner. No surprise, then, that I spoke on the phone with several clients today, all anxious to make year-end gifts to their grandkids.
For grandparents who have the means to do so, it’s a caring gesture showing their love for their grandchildren, and acknowledging just how expensive it is today to raise and educate a child.
So let me share with you a few tips about gifting strategies we think work well, and what we suggest you avoid.
Gifts need not be big. Each person can normally gift up to $14,000 per person per year without filing gift tax returns (special reporting rules apply when gifts are made jointly with a spouse, or when bundling five years of gifts to a 529 College Plan).
But many clients make smaller gifts of $500 or so, and let’s not forget – those gifts can still grow big over time. Many of the 529 College Plans we use accept smaller initial gifts, as do many brokerage firms. And, you can add money over time.
Gift tax smart. We love super tax-smart gifts like contributions to 529 College Plans. The money you put in these plans grows free of tax for years and years. In fact, if taken out to pay for qualified education expenses, there’s no tax at all. That makes it a true holiday bargain!
Contrast this with an old-fashioned minor’s custodial account, where you have to pay tax on growth every year at your highest tax rate. That could eat up 1/3 of the growth each year, leaving your grandchild holding the short end of the stick.
Gift for growth. There’s nothing sadder than seeing money gifted to a one-year-old stuck for two decades in a CD earning … 1%.
(And if it’s in a custodial account, it’s even worse. A big chunk of that one percent will go to the IRS each year.) Gifts to grandchildren can and should take advantage of long-term growth investment strategies since it may be fifteen or twenty years, or even longer, before that money is needed. So go for growth or go home.
Let’s say you gift $1,000 each year to your newborn grandchild. Invest in a CD, and by age 21, your grandbaby will have about $24,000 saved thanks to your $21,000 total investment (assuming no taxes and growth of 1% annually).
But here’s a better option. Invest for moderate growth, like you would in a 529 plan, and your grandchild’s stash grows to almost $45,000 given the same contributions and a 6% annual return.
Be honest … more than doubling your grandbaby’s money, or earning a paltry return. Which outcome would you choose?
Gift control. You’d be amazed to learn how many grandparents are hesitant to gift to their own kids, not because they don’t love them, but because they’re “not good with money.”
So the challenge is how to help the grandkids without handing the money over to their parents. You can do that using a custodial account, but there are significant tax, financial aid and other disadvantages, plus the kids get total control of the money at age 21 or earlier (Harley Davidson, anyone?).
For better results, use a 529 College Plan. The gift is for your grandchild, whom you designate as the beneficiary. But as the account holder, you remain firmly in charge, and can even redirect your gift if needed to another family member.
Gifts to last. Got older grandkids? You can contribute to a Roth IRA on your grandchild’s behalf if he or she has any working income. There is absolutely no better gift you could ever make. It could help your grandchild finance an education, buy his first house, or start her own business, with an unbeatable lifetime tax-free guarantee.