From what I can tell, grandparents might have the best gig within the family unit. Set aside the inherent celebrity status that comes with the title of Grandma or Grandpa. Instead, just consider the immeasurable love received from grandkids at a fraction of the parenting workload. Talk about a phenomenal return on investment.
Solidifying your status as the ultimate alternative to mom and dad is often as easy as making the surprise detour to the ice cream stand. Or showing that extra level of patience as they get their shoes on. But sometimes Grandma and Grandpa want to go above and beyond. Sometimes they’re fortunate enough to be in a position to make a meaningful contribution to their grandkids’ financial future. The question then becomes: How do you make it count?
There is no shortage of accounts that grandparents can choose from. However, identifying the optimal account to contribute towards depends on how and when you envision that money ultimately being used.
529 - College Funding
Oftentimes our first thought goes to supporting a grandchild’s education, so let’s start right there. Not only is education one of the most meaningful ways to contribute to a child’s future, but it also happens to be the single biggest financial outlay associated with parenthood nowadays. That’s why I always emphasize that both the parents and the child ultimately benefit from grandparent 529 contributions. The parents get ahead of schedule on their child’s education savings, which likely frees up their current cashflow. And of course the grandchild benefits from a lesser eventual student loan balance, or perhaps even a debt free education. Win-win!
529 contributions offer some pretty unique tax advantages that should not be taken lightly. Money contributed to a 529 is invested and grows tax-deferred, meaning no tax is owed on the dividends and gains each year. Furthermore, funds withdrawn from the account are income tax free when used for qualified educational expenses. That’s not the case with the other options we’ll be looking at. In essence, 529 gifts eliminate any “tax drag”, which allows for the maximum after-tax value of the gift.
While the tax advantages are attractive, 529 accounts offer a fairly narrow scope for usage compared to the other accounts. The account has to be used for (you guessed it!) education. Funds can be used for education related costs outside of just tuition (books, room & board, etc.), but they don’t offer near the flexibility compared to some other options. Overall, 529 contributions generally create a multi-generational tax-efficient benefit, but lack flexibility in how the funds will ultimately be used.
UTMA - Multi-Purpose
If you’re looking for maximum flexibility in how funds can be used, a Universal Trust to Minors Account (UTMA) might be your best option. A UTMA is an investment account that can be opened and managed by a parent or grandparent on behalf of the child. Contributions can remain invested or be withdrawn during childhood if they’re used for the direct benefit of the child. Eventually when the child reaches the age of majority they take full control and ownership of the account balance. (Note: the age of majority varies from state to state, generally ranging from age 18-21)
Generally, parents and grandparents intentionally leave contributions invested / untouched throughout childhood until the child eventually takes control of the account. Most of the time grandparents will be perfectly fine turning the keys over to their now adult grandchild. However, at that point it is completely the grandchild’s decision on what happens to that money. In some cases they may choose to keep that money invested, use it as a downpayment for their first house, or pay for their wedding. In others cases it may go towards something grandparents might not fully approve of. The point is that with the added flexibility of UTMAs, comes a lack of control in how the funds are eventually used.
Trump Account - Retirement Saving
Trump Accounts are the newest option on the block, and perhaps the most intriguing from a wealth accumulation perspective. Unlike a 529 or UTMA, Trump Accounts are specifically designed to give the child an early leg up on retirement savings. It’s essentially a special type of traditional IRA for children. That means a grandparent can make a contribution today knowing that, barring a few limited exceptions, the money is likely to enjoy tax-deferred growth for many more decades when compared to 529s and UTMAs. That presents an interesting opportunity from an investment growth perspective. Where a relatively small initial contribution could grow by many more multiples in comparison to the same amount invested in a 529 or UTMA.
The biggest advantage of a Trump Account is also its biggest drawback. The money is intended to stay invested for the long haul. During the growth period there is very little flexibility to use the money for college tuition, a first car, or a wedding. So, if actually seeing your grandchild enjoy your gift in early adulthood is the intent it’s probably worth looking at the other two options more closely.
It’s worth mentioning that there’s no restriction on which accounts can be opened on behalf of a child. In theory, if you wanted to diversify your contributions across all three accounts there’s really no significant downside other than a few more passwords to keep track of. I haven’t come across an official name for this approach yet, so I believe I’d be the first to nickname it the Grandparent Grand Slam!
That said, clearly there’s no shortage of accounts to choose from when weighing a financial gift to a grandchild. In fact, there is basically an account out there for every intended use case. Each one offers the similar advantage of allowing money to be invested and grow on the child’s behalf. So, in essence, the decision should ultimately come down to your desired use case for your gift. It’s about making it count in the area you most want to support.
