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Grandparents often give grandchildren unconditional love, reassuring hugs and endless patience. They can also give grandchildren a head start on financial success by investing on their behalf. Investing for your grandchild can take many forms; review your options to choose what you believe is best for your goals and your grandchild.
There are many ways to invest for a grandchild, including brokerage accounts, individual retirement accounts (IRAs), savings bonds, 529 savings plans and Coverdell accounts. You can also leave assets to grandchildren in your will. Here's a closer look at your options.
How to Set Aside Cash for a Grandchild's Future
U.S. savings bonds are securities issued and guaranteed by the federal government that earn interest for up to 30 years. Children will get the best return from a savings bond by holding it until maturity, although they can cash it in earlier.
Savings bonds typically earn a lower rate of return than higher-risk investments such as stocks, but they're generally a safe investment. Minors can hold savings bonds in their own names, making them a tried-and-true way for grandparents to introduce grandkids to the concept of investing.
There are two kinds of U.S. savings bonds:
- Series EE bonds earn a fixed interest rate and are guaranteed to double in value in 20 years.
- Series I bonds combine a fixed interest rate with a variable rate tied to the rate of inflation. Series I bonds don't guarantee a rate of return, but tying interest to inflation helps offset inflation's effect on earnings.
You can buy both types of savings bonds online at TreasuryDirect.gov in increments of $25 to $10,000 or buy paper bonds using your federal income tax refund.
Custodial Brokerage Accounts
A custodial brokerage account for a minor grandchild can be used to invest in securities such as stocks, mutual funds and more. Your grandchild owns the account; you manage it and make the investing decisions until the grandchild reaches legal age. You can gift stock to a grandchild by transferring it from your brokerage account to the custodial account.
There are no limits to how much money you can put into a brokerage account and no penalties for withdrawing funds. However, you may owe capital gains taxes on earnings. Keep in mind that money in a custodial brokerage account is typically considered part of a child's assets, which could make it harder for your grandchild to get college financial aid.
Custodial Individual Retirement Accounts (IRAs)
If your grandchild earns income through a part-time job, consider opening a custodial IRA with a brokerage or other financial institution. Funds in a custodial IRA belong to the grandchild; you manage the account until the child reaches adulthood, when the account converts to a regular IRA.
You can choose a traditional or Roth IRA for your custodial account. Contributions to traditional IRAs are tax-deductible; your grandchild pays taxes when funds are withdrawn. Contributions to Roth IRAs are made after-tax; no taxes are owed upon withdrawal. Roth IRAs generally make more sense for minors, whose incomes are typically so low that tax deductions aren't a concern.
For 2023, contributions to a Roth IRA are limited to the lesser of the child's annual earned income or $6,500. Both types of IRA allow penalty-free withdrawals after age 59½; in some cases, money can be withdrawn earlier for higher education costs or a down payment on a first home.
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How to Invest for a Grandchild's Educational Expenses
You have big dreams for your grandchild, including the best college education money can buy. These savings vehicles can help:
A 529 plan lets you save for college and postgraduate education and pay no federal taxes on investment earnings if the funds are used for qualifying education expenses. Some states offer tax deductions or credits for contributing to a 529 plan. There are two kinds of 529 plans:
- Education savings plans can pay for tuition and other expenses related to college or postgraduate education at any qualifying school. They can also pay for K-12 private school tuition and some apprenticeship programs, or repay a certain amount of student loans. Contributions are invested in various assets, such as mutual funds and exchange-traded funds. Typically, you'll choose higher-risk investments at first and move to safer investments as your grandchild approaches 18.
- Prepaid tuition plans let you buy credits toward tuition at a chosen college or university at current prices and use them in the future, even if tuition rises. These plans are more limited than education savings plans. They can't be used for K-12 education or student loans, and usually apply only to in-state public schools.
States offer 529 plans through state programs or participating brokers. You can open a 529 plan in the name of a grandchild (the beneficiary) or contribute to a plan your child owns on behalf of your grandchild. In 2023, you and your spouse can each put $17,000 into your grandchild's 529 plan without triggering gift taxes.
The person who opens the plan owns it and controls the funds, even once the beneficiary turns 18. If your grandchild doesn't use the funds, you can choose another family member as beneficiary. As of January 1, 2024, you can also roll over up to $35,000 in unused 529 funds into a Roth IRA in the beneficiary's name.
Coverdell Education Savings Accounts
Like a 529 plan, a Coverdell education savings account (ESA) allows you to invest money, use it for qualifying college or K-12 expenses and pay no taxes on gains. You can open a Coverdell ESA at brokerages and other financial institutions for minor grandchildren. You own the plan, your grandchild is the beneficiary and anyone can contribute.
You can have both a Coverdell ESA and a 529 plan for the same grandchild. If your grandchild doesn't use the Coverdell ESA funds, you can transfer the account to another family member.
Coverdell ESA contributions aren't tax-deductible, and contributions are limited. If your and your spouse's joint modified annual gross income is $190,000 or less, total annual contributions per beneficiary are limited to $2,000. That includes any contributions other people make. If your combined income is above $190,000 but lower than $220,000, contribution caps are even lower. Putting aside $2,000 or less per year may not be enough to make a dent in college costs.
Alternatives to Monetary Investments
Setting aside liquid cash for your grandchild isn't always an option. You may be putting every extra dollar toward paying down debt, paying off your mortgage or saving for your own retirement. Building grandchildren into your estate plan offers a way to support their financial future without jeopardizing your own financial security.
Consider leaving your grandchildren valuable property they can use, sell or otherwise benefit from financially. For example, leaving your grandchild your home, car, gold or silver, collectibles, fine art, fine jewelry or coin or stamp collections can provide a financial windfall without cutting into your retirement funds. Many such assets appreciate in value over time, and could be tapped for college tuition, a home down payment or an initial contribution to an investment account later on.
Write a will to make your wishes known. Creating a living trust can also help ensure your assets are distributed as you want after your death. You can even designate a trustee to manage any property or financial accounts left to grandchildren until they're old enough to handle managing the assets themselves.
The Bottom Line
Before opening any type of investment account for a grandchild, discuss your options with their parents to ensure you're not duplicating efforts or working at cross-purposes. Also consider potential tax implications for both you and your grandchild, as well as any effect a financial account may have on a grandchild's future eligibility for college financial aid. Consulting your tax planner or financial advisor can help you make the best decision for your grandchild's financial future.
The better shape your own finances are in, the more alternatives you'll have for helping your grandchildren financially. Check your credit report regularly and sign up for free credit monitoring so you can spend less time worrying about financial fraud and more time with your grandkids.