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4 Tax Benefits to Help Save for Your Grandchildren

by
Steward Financial
on
9/13/2016
4 Tax Benefits to Help Save for Your Grandchildren

There is no experience quite like that of being a grandparent, and if you are fortunate enough to be in that position, then you are no doubt interested in doing all that you can to make sure that your child’s child has all the advantages you can possible provide. There are a number of ways that the tax code allows you to do this, and though they may not offer you a benefit on your current taxes, they do have the advantage of helping the kids while also reducing your estate taxes in the future. 

Beyond the sheer joy of gifting your grandchildren with toys and treats, there are also significant ways that you can provide them with a more secure future. Gifts that provide them with funds for their retirement or their education are extremely meaningful, and the IRS rules have facilitated this with the establishment of an annual gift tax exclusion. This exclusion represents the amount that each person is permitted to give to another person each year without having to report the gift. The amount can change each year based on inflation, and is currently fixed at $14,000.

That means that you can give each of your grandchildren with a $14,000 gift – and so can your spouse – without it being a taxable event. Gifts that exceed the $14,000 gift tax exclusion require the filing of Form 709 the Gift Tax Return, and will also be counted against the lifetime gift and estate tax exclusion.  For tax year 2016, the lifetime exclusion is $5.45 million.

Knowing that you are permitted to provide in this way opens the door to a number of attractive gifting opportunities. Some of the best options include:

Educational Savings:

There are a couple of ways that you can contribute financially to a grandchild’s education. If you are interested in specifically providing funds for a college tuition, then you may be interested in the popular Section 529 plans. Also known as Qualified Tuition Plans, these provide the opportunity to save large amounts of money that accumulate tax free and can then be used for qualified college expenses. Though a grandparent is still limited to the $14,000 per year gift tax exclusion, the plans themselves have no income or age limitations. Though they may have a maximum amount that can be contributed over time, these limits are generally based upon what a college education costs.

Each plan establishes its own limits, but these are generally based on at minimum the cost of a four-year education in state, and some base their maximum on the costs of tuition at the nation’s most expensive private institutions. For grandparents who would like to make a large lump sum contribution beyond the $14,000 annual limit, there is the opportunity to make an upfront contribution that is the equivalent of five years’ worth of gifts, but this does require that the gift tax return is completed and will count against the lifetime exclusion.

If your interest in providing for your grandchild’s education extends to the years before college, a Coverdell Education Account may be more appealing to you. Unlike the 529 plans, these accounts may be used for educational spending as early as the kindergarten years. They have the same tax-free accumulation advantage that the 529 plans do, but offer more flexibility in how the money is spent. They also have more limitations and some rules that may be viewed as a disadvantage.

The maximum amount that can be contributed to a Coverdell account each year is limited to just $2,000, and once the money has been deposited it may fall under the child’s control once they achieve the age of majority in the state where the account is. By contrast, contributions made into a 529 plan remain under the control of the contributor, permitting you to have more say in how the money ends up being spent.

Retirement:

It may be a challenge to think about your grandchildren’s need for retirement money, but just as you aged, so will they – and they will need a nest egg. If your grandchild is old enough to work you might want to discuss the advantages of savings with them, and one of the best ways to do so is to encourage them to open an IRA. A Roth IRA is probably a better bet for a child that isn’t earning that much income as compared to a traditional IRA, and earns interest tax free. It also has the benefit of having its distributions available without taxes once the child is at retirement age.

Contributions are limited by either their earned income or a $5,500 limit (whichever is lower), and you can include a contribution into the IRA as part of your $14,000 annual allowed gift expense. So for example, if your grandchild has a part time job and they earn $3,500 in tax year 2016, then you can contribute $3,500 into a Roth IRA for their retirement and still be permitted to spend another $10,500 on other gifts or contributions without having to file a gift tax return. Any gift beyond that would count against the amount that you are permitted to give over the course of your lifetime.

Direct Payment Exclusions:

Grandparents are also permitted to make additional contributions that go beyond the annual gift tax exclusion. These excluded amounts are paid directly to institutions for either educational purposes or medical purposes.

  • You are permitted to provide direct payment to any practitioner or entity that is providing medical care or treatment
  • You are permitted to provide direct payment to any college or private primary educational institution for the costs of education. In doing so, you may be able to provide a tax credit for the person that claims your grandchild as a dependent. Expenses for books, room and board are not eligible for this exclusion.

There is a critical difference between this method of providing for a grandchild and funding a 529 plan – these payments must be made directly to the provider or institution that is billing for the services.

Trusts:

Finally, with the help of an estate planning and trusts attorney, grandparents are able to establish trusts that allocate and distribute funds at a later point in your grandchild’s life. These can be based on certain contingencies or milestones as dictated by you and your preferences.

Providing for your grandchildren’s future serves a number of important purposes. It allows you the joy of knowing that you have paved the way for a more secure future for your children’s children, while at the same time creating a legacy and sending a message about the importance of education. It also provides you with an effective method of reducing the value of your estate.

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Steward Financial

Steward Financial

Jon Osborn is a tax preparer based in San Dimas, California. His company, Steward Financial Services, offers a broad range of tax preparation, accounting and business consulting for small businesses. He loves to work with clients who are looking for answers to complex tax and business planning issues. He has owned several small businesses and worked with over one hundred small business owners. He helps his individual and business tax clients find the best ways to spend their money in order to minimize IRS tax. Small businesses looking to grow, sell or just increase cash flow are one of Jon's specialties.

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