11 May Savings options for grandparents

Q. I’m thinking of investing for my grandchildren who are 5 and 7. I’d like to do a monthly amount but I’m not sure what kind of account I should use. Maybe a 529 plan? Can you suggest something?
— Grandparent

A. Your grandchildren are very lucky to have you.

Putting away a monthly amount for them is great if you can afford it.

Here’s a look at some savings options for college.

Savings in a Coverdell Education Savings Account, or ESA, can be used for college tuition, private secondary school or other education expenses, said Bill Connington of Connington Wealth Management in Paramus.

These accounts used to be known as Education IRAs.

He said Coverdells allow families to save up to $2,000 a year for students under 18.

“Coverdell funds grow tax-free, but like IRAs, these accounts are only as profitable as their underlying investments,” Connington said. “For savers who want a wide array of investment options, Coverdells offer greater selection than other education savings vehicles, like 529 plans.”

But even if you max out the contribution limit every year, it won’t be enough to pay for college.

Coverdells are available to families with gross adjusted incomes of $220,000 for married couples or $110,000 for single tax filers, Connington said.

The funds must be used for qualified educational expenses or else you’ll pay a 10 percent penalty and back taxes on earnings when you take withdrawals.

He said Coverdell funds can be taken out for qualified education expenses at any time, but contributions can’t be made after the beneficiary is over 18 and the funds must be used by the time the beneficiary reaches age 30.

“Unless you’re the only one contributing, you’ll also need to coordinate with other investors to make sure you don’t exceed the $2,000 limit,” Connington said.

Then there are 529 Plans. These offer federal, and sometimes state, tax advantages.

529s come in two forms. There are prepaid plans, which allow grandparents (or anyone) to purchase tuition credits at a rate that’s nominally higher than today’s prices and trade them in once the child is ready for school. And then there are 529 college savings plans, which allow families to select an investment portfolio their account is tied to, Connington said.

Both plans offer tax-free growth, make a minimal dent in the student’s financial aid package if the account is held in the child’s or child’s parents name, and can be used all at once to cover qualified expenses or throughout the student’s college tenure, he said.

If you yake 529 money out for a non-education expense and you’ll pay a 10 percent penalty on plan earnings and back taxes on the funds.

“Except for the Private College 529 plan which is designed for students attending private colleges and universities, 529 plans are administered through individual states, though many states only offer one of the two types of plans,” he said. “You can invest in any state’s plan, regardless where you or the beneficiary live, but many states also offer state tax deductions or credits on top of federal tax incentives to those who invest in their state’s plan.”

New Jersey’s plan doesn’t offer any tax benefits.

529 Plans come with high contribution limits — in many states, it’s $250,000 to $300,000 — and with extra incentives for family members who are looking to unload lots of cash fast.

Contributors can give up to $14,000 from a single person or $28,000 from a married couple per year without incurring federal gift tax, Connington said.

“Contributing to a 529 can be as easy as buying groceries, gas or any other daily necessity,” he said. “Some Credit Cards offer cash back rewards that can be deposited in a 529 college savings plan in your grandchild’s name also.”

Or, you can make a contribution on a monthly basis and choose how the money is invested but the options are limited to the 529 Plan.

You can also consider setting up a trust fund for your grandchild’s fiscal future which will also reduce the size of your estate, but that only makes sense if you’re moving serious money, Connington said.

“Trusts allow grandparents to move just about any asset on Earth and to stipulate how assets can be used,” Connington said. “The drawback is that they’re costly.”

He said if you’re giving $5,000, or investing on a monthly basis, then a trust is probably not economical because you could pay anywhere from $1,500 to $5,000 to have one created.

For smaller gifts, Uniform Gift to Minors Act accounts (UGMAs) and Uniform Transfer to Minors Act accounts (UTMAs) could be considered, Connington said.

These accounts are held in a custodian’s name — usually the grandchild’s parent — and are tied to underlying investments, meaning that they can gain or lose money depending on the market, he said.

“One benefit — or drawback depending on how you see it — is that UGMA and UTMA funds don’t necessarily need to be used for college,” he said. “Once the beneficiary is of age, funds can be used for any purpose and these accounts don’t have limits on the amount you can contribute, though annual gifts of more than $14,000 from a single person ($28,000 from a married couple) will be subject to federal gift tax of up to 40 percent.”

Connington said UTMAs and UGMAs offer some federal tax advantages. In 2016, the first $1,050 of plan earnings is tax-free and for beneficiaries under age 18, and the next $1,050 is taxed at the child’s tax rate, which is generally lower than the tax rate for the account holder. Anything earnings over $2,100 are taxed at the account holder’s rate.

“The real decision is the options you want to have available to you in regard to investment flexibility and what your goal is for the grandchildren,” Connington said. “To just pay for education, for whatever they want to do with it or a combination of both. Decide that first and the right way to do it will be made very clear to you.”

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This post was first published in May 2016.