A Grandparent's Guide to Saving & Investing for Grandkids
By Richard Eisenberg, guest blogger
One of the best things a new grandparent can do for your grandchild is to invest for their future. Not only will this be a lovely gift now, but it may also be a huge help down the road if your grown child could use assistance paying for your grandchild’s college tuition.
College financing expert Mark Kantrowitz noted on the “Friends Talk Money” podcast I co-host that there’s a huge advantage to investing for the eventual college bills of your grandchild while they’re very young.
If you start saving for your grandchild’s future at birth, he said, about a third of the college-savings goal will come from the earnings. But if you wait until the grandchild enters high school, less than 10% will come from the earnings. That means you or your grandchild’s parent will need to save about six times as much per month to reach the same goal.
In 2024, you can give up to $18,000 to a grandchild without incurring a gift tax; up to $36,000 if you’re married. Those limits are adjusted annually for inflation.
The best ways to save for grandkids
The simplest way to invest for your grandchild, of course, is by making an outright gift. The most complicated and expensive way is by setting up a trust. But there are three other ways worth considering; some offer tax advantages for you, too.
They are custodial accounts known as UGMAs (Uniform Gifts to Minors Account) and UTMAs (Uniform Transfer to Minors Account), U.S. Savings Bonds, and college savings accounts. When your grandchild is old enough to have earned income, you could then consider opening and funding a tax-advantaged custodial Roth IRA account for them.
Investing for grandchildren with UGMA and UTMA accounts
With an UGMA (Uniform Gift to Minors Act) or an UTMA (Uniform Transfers to Minors Act) account, you open and fund the taxable account for your grandchild at a bank, credit union or broker. An UGMA account, valid in every state, lets you make gifts of cash, stocks, bonds and mutual funds. An UTMA account, valid everywhere except South Carolina and Vermont, lets you also gift art and real estate.
The first $2,500 of interest, dividends, and capital gains in the account in 2024 is taxed at a lower rate than the parent’s; that threshold adjusts with inflation, too.
There are three downsides to UGMAs and UTMAs:
The gift is irrevocable.
Your grandchild will get full control over the account when they are no longer a minor, usually at age 18 or 21.
These accounts reduce the grandchild’s eligibility for need-based financial aid for college.
Are U.S. Savings Bonds a good way to save for grandchildren?
Savings Bonds, known as Series I Bonds or Series EE Bonds, are good investments for a grandchild because they’re convenient, have no fees and are ultrasafe. Their monthly interest is guaranteed by the U.S. government for the 30-year life of the bonds.
Uncle Sam has an incentive for you to buy them, too. The interest is exempt from state and local income taxes.
Both types of Savings Bonds are sold through the TreasuryDirect program. Use the Buy Direct tab on its website, click “This is a gift” and then — to deliver the bond — the “Gift Box” tab. TreasuryDirect even has cute gift announcements you can create.
To give your grandchild a Savings Bond, you and the child (or their parent or custodian) must have a TreasuryDirect account and you’ll need to know your grandchild’s Social Security number.
You can buy, and gift, I Bonds or EE Bonds electronically for an amount of as little $25 and as much as $10,000. Paper I Bonds can be bought through your tax refund; there’s a $5,000 annual limit. Paper I bonds cost $50, $100, $200, $500 or $1,000.
U.S. Savings Bonds can be cashed in after 12 months, but if they’re redeemed within five years, the owner loses their last three months of interest.
The I in I Bonds stands for Inflation because these bonds have a fixed interest rate (currently 1.3%) and an inflation-adjusted rate that changes every six months based on the cost of living. The government guarantees that an I Bond’s interest rate will never dip below zero. The overall current rate for I Bonds is 5.27%.
EE Bonds earn a fixed rate of interest and are guaranteed to double in value in 20 years. Their interest rate (currently 2.70%) stays the same for at least the first 20 years and can change during the last 10 years of the bond.
Setting up tax-advantaged accounts for grandkids’ education
There are three types of college savings accounts you can open and fund for your grandchild and each offers tax-free investment growth and tax-free withdrawals when the money is used to pay for your grandchild’s college education.
Two of these accounts — state-sponsored 529 plans and prepaid tuition plans — are offered through the programs’ websites and financial institutions. It’s typically less expensive to purchase them directly from the states.
The third type is a federal Coverdell Education Savings Account (ESA), sold by financial institutions.
The 529 plans are the granddaddy of them all because they’re run by every state and you can open one with as little as $500 or $1,000. These plans let you choose among various diversified investment choices run by their managers; you may want an age-based account whose investments grow less risky as your grandchild’s college years approach.
The money you contribute grows tax-free and your grandchild will be able to use the 529 for any college in any state. Distributions for education expenses are tax-free, too,
More than 30 states also let residents claim a state income tax deduction or credit for 529 contributions, generally when the plan is from your home state.
If your grandchild ultimately decides not to attend college, you can change the beneficiary to another relative or take the money out and pay taxes plus a 10% penalty on the earnings.
The Savingforcollege.com has a helpful interactive tool that lets you compare 529 plans around the country.
The big news is that starting with the 2024-25 academic year, 529 accounts owned by grandparents will no longer reduce a grandchild’s eligibility for financial aid.
One little-known fact about 529s: If you opened one for your child years ago and there’s still money left in it, you can transfer the cash into a new 529 for your grandchild. I did this myself recently.
Prepaid tuition plans are offered by just nine states (Florida, Maryland, Massachusetts, Michigan, Mississippi, Nevada, Pennsylvania, Texas and Washington). They let you lock in college costs at today’s rates for higher-ed institutions in their states and their managers choose how to invest the money.
Usually, prepaid plans are based on the cost of in-state tuition at a public college there. Some also pay a proportion of tuition out-of-state.
There’s also the Private College 529 Plan, a prepaid tuition program for residents of the other 41 states that can be used at roughly 300 private colleges and universities around the country.
What happens to 529 funds if your grandchild doesn’t go to college? You may be able to change the prepaid tuition plan’s beneficiary or get your contributions back.
Like 529s, prepaid tuition earnings grow tax-free and remain tax-free when used to pay for tuition. You may qualify for a state tax deduction for prepaid tuition contributions, too.
Coverdell ESAs are the most restrictive type of college savings account because they have tough rules about who can contribute to them and how much.
You must have earned income and in 2024, your income must be under $110,000 (under $220,000 if you’re married filing a joint tax return). The annual contribution has a $2,000 maximum and that amount is reduced for incomes of $95,000 to $110,000 ($190,000 to $220,000 for married couples).
Contributions to these accounts and earnings on the ESAS belong to your grandchild. You must stop making contributions when your grandchild turns 18.
Where to get more information on college savings plans for grandchildren
For additional details about these plans, visit these websites: The Department of Education’s Studentaid.gov, Thecollegeinvestor.com, Finaid.org and Savingforcollege.com.
Richard Eisenberg writes “The View From Unretirement” column for MarketWatch and co-hosts the “Friends Talk Money” podcast.