6 Ways You Can Set Up Savings for Your Grandchildren
Most grandparents love helping out their grandchildren when they can.
Some grandparents help out by watching their grandkids while their parents work. Others want to contribute in other ways, such as monetarily.
It’s important to realize that not every grandparent will be able to financially help out their grandkids.
That said, many grandparents do want to set aside some money to help their grandchildren.
The reasons vary. Some grandparents may have struggled to afford their education or their first home. They simply want to help their grandkids get an easier start to their life.
Others want to help their children avoid the burden of saving for their grandchildren's college educations -- or taking on student loan debt.
No matter the reason, grandparents can save for their grandchildren in many ways.
So, if a grandparent is asking you how to contribute to your child’s financial future or you’re the grandparent wanting to help out, here are a few options that may work for you.
Before You Get Started…
Before you get started, realize that how you choose to save for your grandchild’s future matters.
Who owns the funds?
First, it matters whether you keep the funds in your name or put them in your grandchild’s name.
The money you save could hurt your grandchild's financial aid application. This is mainly true if the money is in your grandchild's name.
The Free Application for Federal Student Aid (FAFSA) calculates how much financial aid a person should get based on a specific formula.
That formula heavily penalizes students for money held in their name when determining their ability to pay for college.
Access to the funds
Next, if the money is put in your grandchild’s name, they may be able to access the money before you intended them to use it.
They may also use the money in ways other than what you intended for them to use it for.
Once a child turns 18, or 21 depending on the state, a child can usually access any funds in their name. That also means they can use them for whatever they see fit.
You can keep control of how the money is used if you keep it in your name and simply name your grandchild a beneficiary.
This way you won’t have to deal with an 18 year old blowing thousands of dollars tricking out an old car.
1. Savings Account
One of the easiest ways to save money for your grandchild is a savings account. Unfortunately, the easiest choices are rarely the best choices.
Putting money in a savings account means the money you set aside for your grandchild won’t decrease in a total dollar sense. Most savings accounts are FDIC-insured up to $250,000.
That said, the interest rates offered on most savings accounts are usually below the rate of inflation.
This means the purchasing power of the money you put away today could decrease over time.
This is especially true if the inflation rate constantly exceeds the rate you earn on the money.
If you do decide to open a savings account to set aside money for your grandchild, make sure you pick a high-yield savings account.
Picking a savings account with a competitive rate can help offset inflation as much as possible.
2. Certificates of Deposit
If you’re looking for a higher return than a savings account but still want the security of knowing the money you set aside won’t technically decrease, consider certificates of deposit (CDs).
CDs allow you to earn a higher interest rate on your money in exchange for the promise that you won’t withdraw the money for a certain period.
Terms of CDs can be as short as a few months or as long as many years. The longer-term CDs generally offer higher interest rates.
Keep in mind, you may not want to lock into a long-term CD if interest rates are on the rise. Why? CD rates are fixed when you start the CD and don’t change in most cases.
3. Brokerage Account
If you’re willing to endure risk for potentially higher returns, you may want to invest the money you’re setting aside in a brokerage account.
Opening a brokerage account allows you to invest in stocks, bonds, mutual funds, ETFs and other types of investments.
These investments may provide higher returns than savings accounts and CDs over long periods of time. That said, there is also a risk that the money you invest could lose value.
But, if you’re investing at the beginning of a grandchild’s life, you have at least 18 years to invest before they’ll need the money for college or a down payment on a home.
Eighteen years is a fairly long time horizon when it comes to investing. This longer time period allows many people to feel more comfortable with the risks they take.
The years where your investment goes down may eventually be balanced out by good years.
As the need for the money draws closer, adjust your investments to match the risk you’re willing to take over shorter time horizons.
The potential growth could easily help the money you set aside to double in value, or more, if you maintain a disciplined investing strategy.
Uniform Gifts to Minors Act (UGMA) and Uniform Transfer to Minors Act (UTMA) are both frameworks that allow parents or grandparents to give money to minors without having to set up a trust.
These types of custodial accounts make giving money to grandchildren much easier than going the traditional trust route. A grandparent can act as the custodian and manage the money.
Accounts are fairly easy to set up and money set aside can be invested in many types of assets, including mutual funds, stocks and bonds. Yet, once you give money using a UGMA or UTMA, you can’t take it back.
Additionally, your grandchild gets access to the money when they reach your state’s mandated age which is usually 18 or 21.
If the UGMA or UTMA account earns investment income, the first $1,050 is tax-free.
Income beyond the first $1,050 will be taxed. This requires filling out tax returns that may not have otherwise been necessary.
5. 529 Education Savings Plans
529 education savings plans allow you to save or invest for future education costs in a tax-advantaged manner. Technically, they are a type of qualified tuition plan.
You won’t get a tax deduction for contributions to a 529 education savings plan. That said, the earnings generated by the investments within the plan will grow tax-free.
You won’t be taxed on the federal level when the money is withdrawn to pay for qualifying educational expenses, either.
Initially, money set aside in 529 education savings plans was only allowed to be used for qualified higher education expenses.
Recent federal tax law changes have affected how you can use money in a 529 education savings plan.
It can now be used for expenses for public, private and religious kindergarten through 12th grade.
The person that sets up the account controls the money and investments in the account. They can name a beneficiary, such as a grandchild, to use the money.
The beneficiary can be changed if a grandchild doesn’t need the money. However, there are tax penalties if you withdraw the money for non-qualifying expenses.
Of course, state laws may differ from federal laws, so make sure to check with your state to see how the tax advantages apply to your state tax situation.
If your state offers tax breaks for investing in a 529 education savings plan, you’re likely best off investing in your state’s plan.
If your state doesn’t offer any tax breaks, it makes sense to find the best state plan for your situation.
6. 529 Prepaid Tuition Plans
529 prepaid tuition plans are another tax-advantaged savings option. They have similar tax advantages as 529 college savings plans.
With 529 prepaid tuition plans, you don't invest the money on your own.
Instead, prepaid tuition plans guarantee that the money you put in will grow at the same rate as college costs in that state.
Essentially, the person investing in the 529 prepaid tuition plan buys a partial year of college at today’s cost with each investment. Each time you invest, you lock in the price of tuition for the amount you invest.
Over time, the cost of college increases and the prepaid tuition benefit increases in value with it.
When the beneficiary attends college, those paid for years of college will reduce the beneficiary’s college costs at an in-state public college.
The rules vary from state to state. However, if a beneficiary decides to attend a private college or out of state school, the plan will typically pay the equivalent of the in-state tuition at a public college.
If a beneficiary decides not to attend college, you can change the beneficiary.
The Decision Is Yours
Saving for your grandchild’s future can seem overwhelming with all the options you have available to you.
It’s impossible to know what your newborn grandchild’s life will look like 18 years down the road. They may or may not want to attend college or need money for private school before college.
That said, they may need all the help they can get to pay for the degree of their dreams. It’s up to you to decide how you want to save or invest the money you want to set aside for your grandchild’s future.
It is your money, after all. Just remember, your grandchild will likely be thankful for whatever help you offer in whichever form you choose.
The important part is to start saving or investing as soon as possible. This way you can set aside as much money as you wish and allow that money to grow with time.