Over the next couple of decades, Americans — mostly aging Baby Boomers and Gen Xers — are expected to pass along about $73 trillion in wealth to their heirs. They will give another $12 trillion to charity. If you will be part of this generous cohort, you could leave everything to be sorted out after you’re gone, or you could make financial gifts while you’re alive. Either way, who’s likely to stand at or near the top of your list?
“With many clients, the attitude is ‘We’ve already spoiled our kids all their lives. Now it’s time to spoil the grandkids.’” says Hagen Pruemm, a financial adviser in Naperville, Ill.
Yes, your grandchildren — whom you’ve loved and nurtured and, guilty-as-charged, spoiled — and who are now facing an uncertain future. Beginning with the dot-com crash of 2000, through the Great Recession, climate change, the pandemic, all the way up to today's volatile political atmosphere, the children of the 21st century have already seen their share of economic shocks and social disruption. And they’ll certainly see more.
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“Gen Zs and Millennials are deeply worried about the state of the world,” reports Deloitte, the giant consulting firm that annually surveys the world’s younger generations. “They are struggling with financial anxiety … they feel burned out.”
The younger group, Gen Z, reports unusually high levels of mental health problems.
It’s no wonder then that you may want the kids to have a financial leg up. The world’s not getting any cheaper. Whether they are already young adults or still in diapers, the grandchildren could use the money to pay ever-increasing college costs, to buy a house or to start a business. Your children — their parents — on the other hand, are likely to be in their own peak earning years, paying tuition and preparing for their own retirement.
A big tax break due to end
Transferring property while you’re still alive lets you enjoy seeing first-hand your grandchildren benefit from your gift. It could also help from a tax-planning perspective. First, there’s a $17,000 a year gift you can make to each grandchild without it counting against the lifetime limit of the estate tax credit. Right now, that’s $12.92 million in property over your lifetime as gifts or inheritances without owing federal taxes. But this high limit is set to be cut in half by 2026 and could fall even further depending on what Congress does. In 2010, the limit was just $1 million.
“Some folks are accelerating their gifting now worried about the tax exclusion going down,” says Paul Karger, a chartered financial analyst and cofounder of TwinFocus, a family financial planning firm in Boston. Since the typical grandparents spend $2,562 annually on their grandkids, most will not run into tax issues with their gifts.
Still, even without the tax concerns, giving thousands of dollars or more to a young family member is not a decision you should rush. These are different gifting methods and strategies that can help your loved ones make the most of your generosity while also improving your relationship.
Different ways to give
▮529 plans are more flexible than you may think. Given the high cost of college these days, it’s no wonder Karger finds a top reason grandparents give money is to help pay for school. For this goal, he recommends using 529 plans. These plans are investment accounts to save for college expenses, sponsored by state governments, state agencies and educational institutions. You can also use 529 plans to prepay semesters of college at in-state schools, avoiding future price increases. While there is no federal tax deduction for adding money to a 529 plan, most states offer income tax deductions if you’re a resident and invest in the plan. Nearly every state has at least one 529 plan available–and if it offers a tax deduction, that’s usually your best bet. But you’re not limited to using your home state’s plan.
When you contribute to a 529 plan, you invest your balance in different investment portfolios offered by the program you use. These accounts delay taxes on your gains so long as the money stays in the plan.
When your grandchild attends college, he or she can withdraw the money completely tax-free to pay for education expenses such as tuition, school fees, room and board, and books. If the grandchild doesn’t spend all the money or doesn’t go to college, starting in 2024 he or she can convert up to $35,000 to a Roth IRA for their future retirement. Alternatively, you can use the account to pay for another family member’s education (including your own). If you don’t spend the 529 money on college expenses, you can withdraw it but would owe income tax and a 10% penalty on your investment earnings.
Dick Timmons, a retired Johnson and Johnson employee in Raleigh, N.C., set up 529 plans for both his grandson and granddaughter. “We didn’t want them to graduate with debt,” he says. Once both his grandchildren finish school, Timmons plans to continue funding the accounts to help his future great-grandchildren pay for college one day.
▮Maintain some control with custodial investment accounts. Uniform Gifts to Minors Act (UGMA) and Uniform Transfers to Minors Act (UTMA) accounts are custodial investment accounts. Your grandchild is the owner, but you control and manage the investments on the child’s behalf until he or she becomes an adult, between the ages of 18 and 21, depending on the state.
Custodial accounts give you much more investment flexibility than 529 plans. A 529 plan only lets you put in cash, and then you need to pick among investment portfolios permitted by your state’s organization. With an UGMA account, however, you can pick whatever stocks, bonds, mutual funds and ETFs are available with your broker. UTMA accounts also accept real estate and other property. You can transfer assets you already own into these accounts. Transfers to these accounts are irrevocable. You can’t get the money or property back.
Custodian investment accounts do not delay taxation but do receive favorable tax treatment. In 2023, up to $1,250 of investment earnings are tax-free and the next $1,250 of earnings are taxed at your grandchild’s tax rate rather than your own, which should be lower. Any earnings above would be taxed at the child’s parent’s rate. Since your grandchild owns these accounts, they could hurt eligibility for college student aid. In addition, your grandchildren gain full control over the assets once they reach the age of maturity. “Nothing could stop them from taking the money and buying a Ferrari,” says Pruemm, the Illinois adviser.
▮Get them started saving for retirement. If your grandchildren have jobs and are earning income that they are reporting to the IRS, you can help set up and contribute to their IRA. Angie O’Leary, head of wealth planning at RBC Wealth Management-U.S., appreciates retirement isn’t at the top of a typical teenager’s mind. Instead, she suggests funding the child’s retirement account yourself. “You can contribute up to their earned income for the year or the IRA limit, whichever is lower.” In 2023, someone younger than 50 can put up to $6,500 in an IRA.
Since your grandchild is likely paying little to no income taxes, chances are they would not benefit much using the upfront tax deduction from a traditional IRA. Instead, consider a Roth IRA. You fund the account with after-tax dollars. Once your grandchildren retire, their withdrawals, including decades of investment growth, will be tax-free.
▮Give straight cash — with strings attached. Karger, the financial analyst from Boston, warns about giving large cash gifts to your grandchildren unless you really trust them with money. “Not everyone is a saver,” he says. “If you give someone cash and it’s sitting in their bank account, there’s a real temptation to spend.”
If you want to give cash directly, O’Leary suggests having some specific purpose behind the gift, like paying for college tuition, a semester abroad, or the down payment on a first home. That way the money goes toward something your grandchild needs, appreciates and will remember, creating more of a legacy.
O’Leary also suggests creating some sort of obligation for earning the cash gift, like the grandchild needs to help you set up a charitable donation first. “Have them do the research and find a charity. That way you tie the meaning of this gift to something bigger.”
▮Show how to handle plastic with a shared credit card. When retiree Dick Timmons’ grandson was in high school, Timmons made him an authorized user on a shared credit card to pay for gas and maintenance. “The bills came to me. I knew what he did with the money.” They used this as a way for Timmons’ grandson to learn how to manage credit in a controlled environment before going to college.
▮Trust funds are best for substantial amounts. A trust fund is a legal entity that holds property for the benefit of someone else. With a trust, you have more control over when the gift/inheritance goes to your grandchildren. For example, you could set up requirements like your grandchild could only receive the money when they turn 25 or for specific life events such as going to college, buying a home, and having children.
Trust funds are expensive though. You will need to pay a lawyer several thousand to set the trust up, as well as annual fees to keep the trust open. For this reason, O’Leary recommends trusts only for substantial gifts, over six figures, or for circumstances where the family member needs assistance with managing the money, like for a grandchild with special needs.
▮Plan ahead to keep things fair. O’Leary cautions about getting overly excited with the gifts for your first grandchild, especially if it looks like you’ll have more than one. “Don’t give too much too early. Otherwise, you might realize you can’t help them all at the same rate or you’ll go broke.” Unequal inheritances can quickly create jealousy and fights between family members. Instead, take your time with the gifting and be thoughtful of how it will stay fair.
▮Hold on to appreciated property and pass it on in your will. As you figure out which assets to give to your grandchildren, Hagen Pruemm in Illinois says you shouldn’t pass on assets that have grown in value, such as real estate or stocks in a taxable account, until after you die. Your heirs will then benefit from a tax break called “stepped-up basis.”
Let’s say you invested $1,000 in Apple stock 20 years ago. That wise investment is now worth over $695,000 today. If you give that stock to your grandchildren and they sell, they’ll owe capital gains taxes on all of the increase in value. But if you wait until death to transfer by will, the cost basis goes up to the value when you pass away. If the Apple stock continues growing to $1 million by the time you die, your heirs can sell and receive that $1 million tax-free. For gifts, Pruemm recommends instead giving cash or assets that haven’t appreciated in value much.
▮Do some tax planning if you’re leaving retirement plans. You cannot give away your IRA or 401(k) directly to your grandchildren. The transfer counts as a withdrawal, so you’d owe taxes on the entire balance first. If you leave the account for your grandchild as an inheritance by naming them the beneficiary, they have more time to delay taxes. Most non-spousal heirs must withdraw and pay all owed taxes within 10 years though. Alternatively, Pruemm suggests using some of your retirement funds to buy a life insurance policy while you’re alive. Your heirs would receive the death benefit payment income-tax free.
▮Keep enough for your own retirement. Before you give money away, Pruemm says to make sure you don’t deprive yourself in retirement, especially in the event of a market crash or a major health care bill. “This is where we see the most regret,” he says, noting people don’t want to take money back from their grandkids and legally can’t with some of the gifting options. “Make sure your own oxygen mask is secure before trying to help others.”
In the end, Timmons, the retiree from North Carolina, ran the numbers and decided giving more to his grandchildren made him happier than other retirement spending. “I could have had a bigger house. I could have driven a Lexus instead of a Honda. My wife and I didn’t sacrifice but decided we could do with fewer personal purchases on behalf of our grandchildren.”
How to talk to your grandchildren about money
You don’t have to become a TikTok star to connect with your grandchildren.
Money is a topic many Americans are terrified to discuss. One out of four Americans admit they have never talked about money with their parents, according to a 2022 survey from GOBankingRates.com.
It can feel even more awkward to discuss with a grandchild 50 or more years younger, speaking what feels like a different language. Boston financial analyst Paul Karger recommends you work with your children to figure out how you’ll both handle these conversations with the grandkids early. “You can’t wait until they head off to college.” Discuss the gifts you have planned and how you and their parents can start teaching the grandkids about using the money properly.
RBC Wealth Management’s O’Leary thinks shared investment accounts are a great way to teach grandkids how to invest. “Talk to the kids about the investments they’re making. Why did they pick the investments? Are they diversifying? Focus on education as well as the gift.”
Pruemm suggests writing a journal in your own words about why you’re making these financial gifts and what you hope the grandchild accomplishes with them. “They’ll see your thoughts and remember the good feelings they had for you. They’ll treat the money more wisely versus running off and buying a fancy car.”
Note: This item first appeared in Kiplinger’s Retirement Report, our popular monthly periodical that covers key concerns of affluent older Americans who are retired or preparing for retirement. Subscribe for retirement advice that’s right on the money.
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