Understand Tax Laws
Tax laws provide many opportunities for grandparents to provide for their grandkids’ financial, educational and other needs. Leaving part of your estate to a grandchild involves additional planning that should be integrated into your overall estate plan. Four grandchild-related strategies are:
- Annual gifts
- Education funding
- Custodial accounts
- Savings bonds
Under 2012 tax law, an individual can make gifts of up to $13,000 per year, per beneficiary, tax-free.
You can also pay directly for your grandchildren’s educational and medical costs. There is no limit on these gifts provided, you pay the school or medical provider directly. You can pay these expenses in addition to making annual gifts.
Current law also allows for a lifetime gift-tax exemption for monetary gifts of up to $5.12 million, This is set to change at the end of 2012, dropping to $1 million. Also, specifically for grandparents giving monetary gifts to their grandkids in 2012, there is a $5.12 million per donor “generation-skipping” tax exemption.
You can invest your gifts immediately in a vehicle such as a brokerage account or a living trust with no adverse tax consequence. This tax exemption includes gifts of cash, securities or other property and contributions to a 529 savings plan, a custodial account, or other qualifying accounts. These gifts are not counted as taxable income to your grandchildren and do not count toward the lifetime gift tax exemption limit.
According to the Census Bureau, college graduates earn, on average, about $1 million more than those without a degree. Contributing to the education of your grandchildren may be a good investment. With the cost of education continuing to rise they may truly need your help.
Section 529 college accounts offer attractive tax benefits for saving money for a child or grandchild’s college education. Anyone can contribute to a Section 529 plan, regardless of income levels or estate value. Contribution limits are high. There are options for how the money can be invested. “Educational expenses” can include things like tuition, housing, books and transportation. All withdrawals are free from federal income taxes, provided the money is used for qualified college expenses.
A beneficiary, usually the person who is expected to attend college, is named when a Section 529 account is opened. The account owner can change beneficiaries at any time. If you name one grandchild as a beneficiary of a 529 plan and that grandchild decides not to go to college, you can switch the account to another grandchild — in other words, you maintain control of the money for the life of the account.
Coverdell Education Savings Account allows for the payment of elementary and high school costs as well as higher education. This is something the 529 accounts do no. Contributions are limited to $2,000 per donor per year.
Earnings in a 529 account that are not used to pay for education will be subject to taxes and penalties. And if you invest in your state’s 529 plan, your contributions may be deductible on your state income taxes.
A custodial account can be set up for a child under age 18. Under the Uniform Gifts to Minors Act (UGMA) and the Uniform Transfers to Minors Act (UTMA), you can make gifts to a custodial account which are counted as taxable income to the grandchild, but the grandchild’s income tax rate is generally lower than that of the person making the gift. You can gift cash, investments, real estate, and more through these accounts.
There are some drawbacks to UGMA/UTMA contributions:
- After you transfer assets into a custodial account, you can’t take them back.
- When the child becomes an adult (generally 18 or 21), the custodian must turn all of the account’s asset over to the child, whether or not the child’s parents or grandparents believe the child is ready
- A custodial account belongs to only one child; thus, you have no flexibility in spreading existing contributions among multiple children or grandchildren.
- Funds in a custodial account can get in the way of a child qualifying for college loans.
You can fund a custodial account with many different types of investments, but the use of the money is entirely up to your grandchildren when they reach the age of termination in whatever state in which they live.
Custodial accounts are best for relatively small dollar amounts because they’re quick, cheap and simple. If you want to transfer thousands of dollars to a child, a trust may be a better vehicle.
If you want to give your grandchildren a financial gift with greater control, you might set up an irrevocable trust. It trust can be funded with either cash or securities. The donor can also specify at the time the trust is created when the funds can be used. You may want the trust to pay your grandchild a certain amount of money in installments over a period of years.
Trusts are complex instruments and may have tax considerations. Consult with an attorney, and discuss your plans with your tax advisor.
If you buy savings bonds in the name of your child, and your son or daughter makes less than $65,600 a year as a single parent or less than $98,400 as a married couple, the proceeds from the sale of the bonds can be used tax-free for your grandchild’s education.
You might also buy zero-coupon bonds, which generally mature in seven to 10 years. Zero-coupon bonds can generate a substantial amount of money for younger grandchildren – depending on the interest rates and yield curve at the time of purchase. Note: if the bond market into which you buy has weak spreads, the return may be smaller than you anticipated.
Medicaid and Gifts
During the five years before a person applies for Medicaid, all gifts are scrutinized carefully by the government. This is called the five-year look back period. A person is not allowed to give a gift in order to become eligible for Medicaid.
In the case that someone receives a financial gift, the value of that gift will have to be paid down before they are eligible to continue receiving benefits. This is the entire value of that gift. If the gift is below the reporting threshold, $1000, then it does not count.