I think most grandparents have a special place in their heart for their grandchildren. Grandparents play with their grandchildren, feed the grandchildren, and generally make life fun for the grandchildren. Grandparents also give the grandchildren back when it is bedtime, or the grandchild is cranky, which makes sense. Grandparents did all of the parental duties for their own children, so now they have the chance to get all of the play and reward without needing to do the hard work. Parents get to do the hard work – not that we parents mind that part – and grandparents are the magical ones who can just play and enjoy grandchildren (and possibly spoil them! ;).
Grandparents want what is best for their grandchildren, just like they wanted what is best for their children. I believe that includes play and affection, but also financial care and assisting a grandchild in paying for their education. I have previously written a blog about setting up educational trust for grandchildren. This blog is not just about trusts, but rather is about how to help your grandchildren to pay for their education, whether you use a trust, or not. Oftentimes a trust is a most helpful and useful tool to pay for the education of your grandchildren, but it is not the only way to help fund education. Grandparents can give outright gifts, set up college education funds using tax advantaged plans, or set up a trust. If you want to specifically set aside funds for your grandchildren, instead of leaving everything to their parents, your children, then you will need to specifically set up something for your grandchildren, separate from what you leave to your children.
Outright Gifts to Your Grandchildren
If your grandchildren are old enough to accept an outright gift, you can directly leave the grandchildren money to pay for education. Gifts to minor children, or even those under the age of 21 for some types of gifts and assets, can be restricted or may cause problems, so an outright gift to a minor grandchild may not be the way to go. Gifts to minor children can be made and put into a type of account created and governed by the Uniform Transfer to Minors Act, called UTMA accounts, custodial accounts, or a similar type of restricted account. These types of gifts can be made and are helpful to minor children, but have very specific rules that must be followed for gifts to a minor.
On the other hand, if you have grandchildren over the age of 18 you can give the grandchildren money directly. You can give money directly to the grandchild, or you can pay college expenses for them. You can do this while you are alive, or after you are gone. You have a lot of flexibility if you give gifts outright to your grandchildren.
Setting Up College Education Funding Investments
There are specific investments that are dedicated to paying for college education, referred to in Colorado as 529 plans. Such accounts can allow you to deduct contributions to the 529 account on your Colorado State Income Tax Return. When the funds in a 529 plan are used for qualified education expenses – tuition, room, board, books, supplies, and the like – then the money that was invested in a 529 plan is not taxable income to you or to the student who uses the money for college. You can contribute money, get a tax deduction, and your grandchild could receive the money tax free if the money is used for higher education.
The downside to a 529 plan is that if the money is not used for higher education, then a payout from a 529 plan is counted as income to a recipient, plus a 10% penalty is added on the earnings inside the investment inside the 529 plan account. So, if you contribute money to a 529 plan, and then that money is not used for educational expenses, but rather paid out to a grandchild for other purposes, then the grandchild will need to pay income tax on what they receive, or you will need to pay income on money you pull back out of a 529 plan. If such funds had simply been given to the grandchild as a gift, the funds could be transferred to a grandchild without the need to pay income tax on what a grandchild receives. So, 529 plans can be helpful, but may not be the best solution, or the only available solution to pay for education.
You Can Set Up a Trust to Fund Your Grandchildren’s Education
One way to preserve a tax advantaged gift to your grandchildren, while still ensuring your assets will be set aside for the grandchildren’s education, is to establish a trust to fund the grandchildren’s education. This can be a stand alone trust, or can be part of an overall trust as part of your estate plan.
A trust established to fund your grandchildren’s education may contain cash, investment account, or other assets, and using the funds may be specified for educational purposes. If there are still funds remaining in the trust once a grandchild’s education has been completed, then the funds in the trust can be distributed to the grandchildren for any other purpose. Such distributions are still considered gifts, so the distributions should not be subject to income tax, like they would be if coming out of a 529 plan. Depending on the type of asset inside the trust, income tax may be due as distributions are made out of an asset. For instance, if an IRA, 401(k), or other tax advantaged account pays out, income tax will still be due, so even with a trust you will want to look at the type of assets put into a trust to minimize the tax due on future distributions to a grandchild.
Trusts provide a great deal of flexibility in dealing with educational expenses and other distributions to grandchildren. You can decide how much you want to contribute to a grandchild’s education, and set up the legal parameters to make sure funds are used for education first, and then for other expenses. You can dictate how the funds can be distributed to your grandchildren, and have the force of the law behind the parameters you establish. You can control the money and how it is used, even after you are gone! Certainly trusts do not solve all of the problems, but a trust can be a useful and helpful tool in many situations.
Choosing the Right Option for You
As with most everything in the law, and in life, there is not one perfect solution for everyone. Each of the options discussed above can be used, or some combination may be the solution for you. Perhaps you can give some gifts now, and set up a trust for the future. Perhaps you can establish a 529 plan to reduce taxes, while setting up a trust to handle excess funds and not have extra taxes on 529 plans that were overfunded. Deciding which option, or combination of options, is best for you is something that you should discuss with an experienced estate planning attorney. You can schedule an appointment to talk to an attorney by going here.