Rebecca Warren: It’s a few short weeks until cap and gown season begins, and for grandparents hoping to do something nice for their grandkids and something sensible for their estate, there are several options to explore.
It’s a few short weeks until cap and gown season begins, and for grandparents hoping to do something nice for their grandkids and something sensible for their estate, there are several options to explore.
Grandparents (or parents) may want to consider setting up and funding a Roth IRA for their grandchildren or children as soon as the grandchildren or children have enough earned income from part-time or summer jobs. This will ensure that the five-year requirement is met when the individual for whom the Roth IRA is established is ready to make a withdrawal to buy a home, for example.
Also, if you have a Roth IRA, you can benefit your grandchildren by naming them as your primary beneficiaries, and when they inherit it, they’ll be able to make tax-free withdrawals for a home, an education or any other purpose.
Another great tool for grandparents is the 529 college savings plan. Grandparents can fill out a plan enrollment form designating a grandchild as beneficiary, select the investments from the plan’s options and make future contributions. It’s also fine for grandparents to make their contributions directly to a 529 account already owned by the grandchild’s parents.
Since 2006, withdrawals from 529 plans have been permanently tax-free. In some states, contributions may also be deductible on state tax returns. All 50 states now have 529 college savings plans, and a majority of them provide additional incentives, such as a state-tax deduction to in-state residents who invest in their respective plan.
It’s a good idea to have your financial adviser help you sort through the details of various state plans. There are various services — including Morningstar Inc. — that now rank the offerings of each state’s plan. Leading sites to help educate you in how these plans work include www.savingforcollege.com and www.finaid.org.
Grandparents can treat their contributions as complete gifts, which means they can apply the $13,000 per year gift tax annual exclusion or an accelerated contribution of up to $65,000, with a special five-year, gift-spreading election. Check with your tax adviser first.
Another great benefit is that a 529 plan owned by grandparents should not affect the grandchild’s eligibility to receive federal financial aid because a grandparent’s assets are not reportable on the free application for federal student aid, or FAFSA, and the tax-free withdrawals from a grandparent-owned 529 plan are not counted as student income or student resources.
For grandchildren heading to private school who are under the age of 18, most grandparents can contribute up to $2,000 annually per grandchild to a Coverdell Educational Savings Account. Coverdell earnings accumulate free of federal income taxes and can be taken to pay for private elementary, secondary or college.
There are income limits on your ability to make Coverdell contributions, so again, check with your tax adviser on this. If you exceed these limits, you can ask the parent of the child to open up the account and make the contribution, though you will have to give up control over the account.
Another option is making a direct gift to the college of your grandchild’s tuition. Under current law, such payments qualify for the unlimited gift tax tuition exclusion. Then you can also go ahead and make additional gifts per grandchild of $13,000 to help with other college expenses.