A guide to savings accounts for your grandchildren

College costs are skyrocketing, student debt is too. As a grandparent, you want to give your grandchildren a head start and help them financially if you can. But before you give them cash or open a savings account, you want to consider all your options. What are the tax implications, for example?

 

To help you decide the best way to save for your grandchildren, we’ve put together a handy guide. Read on for the pros and cons of savings and investment account options, how to open an account for your grandchild and more. 

 

 

 

What’s the best way to save for my grandchild?

There are several ways to save for your grandchild. Which one works best for you will depend on your financial situation and goals. Here are some options to consider:

• 529 College Savings Plan — a state-sponsored investment plan that allows you to save for college expenses. 

• UGMA/UTMA Custodial Account — A custodial account that allows you to transfer assets to a minor. This account is controlled by you until your grandchild reaches 18 or 21 (depending on your state’s law). 

• Coverdell Education Savings Account (ESA) — allows you to save for school and college expenses.

• Custodial Roth IRA — a retirement account you can open in your grandchild’s name if they have an earned income.

• Children’s savings accounts — you can open a savings account in your grandchild’s name from the day they’re born.

• Treasury Direct Account — an online account you can use to buy treasury securities to gift to your grandchild.

• Simple Absolute Trust — allows you to pass down assets to your grandchildren like investments or life insurance payouts. 

• Cash Gifts  — you can gift cash to your grandchild to help boost their savings. But gifts over $16,000 per year (2022) may be subject to gift tax. 

Related: What is saving and why is it important for kids?

 

Savings & investment accounts for grandchildren

There are pros and cons to each type of kids’ savings account or investment account. Before you decide which one is right for you and your grandchild, check the features and benefits of each. Here’s a quick rundown of the drawbacks and advantages of those we’ve outlined above.

 

529 Plans

A 529 plan is a tax-advantaged savings plan for education. It’s a great option for grandparents wanting to contribute to a child’s future college expenses. However, there are some drawbacks. 

 

Pros:

1. Tax advantages:  529 plans aren’t subject to federal income tax, and withdrawals are tax-free too – as long as they’re for qualified education expenses (tuition, books, room and board, or student loan repayments.)

2. Control: as the account owner, you control how funds are invested and when withdrawals are made. This helps ensure the money’s used for education expenses only..

3. Flexibility: you can use 529 plans for trade schools and other non-college educational expenses as well as for college and university. 

4. Gift tax benefits: contributions to 529 plans are considered gifts for tax purposes. You can pay in up to $16,000 per year (2022) without triggering gift tax. See IRS instructions for Form 709 2022.

 

Cons:

1. Impact on child’s financial aid: as 529 plans are considered the owner’s asset, your grandchild may not qualify for need-based financial aid. 

2. Limited investment options: 529 plans are usually limited to a few pre-set investment options only.

3. Withdrawal restrictions: if your grandchild doesn’t use the funds for qualified education expenses withdrawals are taxed and a 10% penalty is payable. Your grandchild must also use all funds before they’re 30 and within ten years of starting college.

4. No guarantee on returns: like any other investment, there is always a risk the account could lose value.

 

Children’s savings account

Children’s savings accounts can be opened in your grandchild’s name and anyone can make deposits. Most banks and credit unions offer these. Look for accounts that don’t require high minimum balances or charge fees for low balances. The sooner you start, the more interest your grandchild will earn —thanks to compounding. 

 

Pros:

1. Easy to open: most banks and credit unions offer accounts for minors. 

2. Low risk: savings accounts are low-risk investments. The money in the account is safe from loss as it’s FDIC-insured. (Up to $250,000 per depositor per insured bank.)  

3. No restrictions on withdrawals: unlike 529 plans there are no restrictions on withdrawals. 

4. Flexibility: you can contribute as much as you wish to your grandchild’s account and the money can be used for any purpose.

 

Cons:

1. Low returns: interest rates on savings accounts are typically much lower than other types of investments such as stocks or funds. This means the account may not keep pace with inflation over time.

2. No tax advantage: interest earned on the account is subject to federal income tax which can reduce your overall return.

3. No control: as soon as your grandchild reaches the age of majority, they’ll have full control over the account and how the money is spent.

4. Impact on child’s financial aid: As with 529 plans, savings accounts are considered the owner’s asset (you, the grandparent) until your grandchild reaches majority age. This can impact their eligibility for need-based financial aid.

 

Custodial Roth IRA

A custodial Roth IRA is like a standard Roth IRA except that the adult controls the account and makes investment decisions on the child’s behalf. You can open and contribute to a custodial Roth IRA as long as your grandchild has an earned income. This could be from a part-time job, a babysitting side hustle, or running a lemonade stand over the summer vacation. 

 

The account remains in your grandchild’s name and all the funds in the account are legally theirs. But you manage the account until your grandchild reaches the age of majority (18 or 21, depending on your state). 

 

Pros: 

1. Tax advantages:  earnings in the account are not subject to federal income tax and withdrawals used for qualified retirement expenses are tax-free. 

2. Long-term growth potential: Because the money in a Roth IRA is invested in the stock market, it has the potential for higher long-term returns than a regular savings account. 

3. Flexibility: contributions can be used for any purpose including education, a down payment on a house or retirement income.

4. Control: as custodian of the account you have control over how the funds are invested and when withdrawals are made. This can help ensure the money is used for what you intended.

 

Cons:

1. Contribution limits: Roth IRA contribution limits are based on your grandchild’s income. This may be lower than the amount you’d like to contribute.

2. Impact on financial aid: As with 529 plans and savings accounts, Custodial Roth IRAs are considered the account owner’s asset so may impact your grandchild’s eligibility for need-based financial aid.

3. No guarantee on returns: As with any investment, there’s no guarantee on returns. There’s always a risk the account could lose value.

 

Coverdell Education Savings Account (ESA)

Named after the late Senator Paul Coverdell who championed its creation in 1997, Coverdell Savings Account can be used to save for your grandchild’s education. Funds can be used for elementary and high school education as well as undergraduate and graduate studies. One of its key benefits is the wide variety of investment types you can make. And this account doesn’t require your grandchild to have any earnings.  

 

Pros: 

1. Tax advantages: Contributions to a Coverdell ESA aren’t tax-deductible, but the money in the account grows tax-free. Withdrawals made for education expenses are tax-free too.

2. Flexibility: You can use the money in the account for a variety of educational expenses, including tuition, books, supplies and room and board.

3. Investment options: Unlike a Treasury Direct account a Coverdell ESA allows you to invest in a wide range of stocks, bonds and mutual funds. Giving you more opportunities to diversify your portfolio and potentially higher returns.

4. Control: You have control over the funds in the account and can choose when and how to use the money. 

 

Cons: 

1. Contribution limits: You can only contribute up to $2,000 per year per child.

2. Income limits: Contributions are limited to individuals with incomes below a certain threshold. This may limit eligibility for some grandparents.

3. Time constraints: Funds must be used for qualified education expenses by the time your grandchild turns 30. That could be a disadvantage if your grandchild decides to delay going to college or university. 

4. Impact on financial aid: Coverdell ESAs may reduce the amount of need-based financial aid your grandchild is eligible for.

Custodial Brokerage – UTMA/UGMA

The Uniform Transfers to Minors Act (UTMA) or Uniform Gifts to Minors Act (UGMA) are state laws allowing an adult to transfer assets to a minor without establishing a trust. You can open a custodial brokerage account (UTMA/UGMA) for your grandchild and manage it until they reach majority age (18/21) depending on the state) when they take over control. There are disadvantages, however, such as tax on withdrawals.

 

Pros: 

1. Flexibility: You can contribute any amount you like to the account. And the money can be used for any purpose.

2. Long-term growth potential: Because the money in a brokerage account is invested in the stock market, it has the potential for higher returns over the long term, compared to a savings account.

3. Control: As a custodian, until your grandchild reaches majority age, you control how the funds are invested and when withdrawals are made. So it’s easier to make sure the money is used for its intended purpose. 

4. Tax advantages: investment income is subject to capital gain tax which is generally lower than federal income tax. Check the IRS’s rules on capital gain tax.

 

Cons:

1. Impact on financial aid: Custodial brokerage accounts are considered the account owner’s assets so they can impact your grandchild’s eligibility for need-based financial aid.

2. Loss of control: When your child turns 18 or 21 (depending on your state’s laws) they take control of the account. You won’t have control over investments or the way the money is used.

3. No guarantee on returns: While custodial brokerage accounts offer long-term growth potential there’s still a risk the account could lose value.

4. Tax implications: Withdrawals can be subject to tax and penalties if your grandchild uses the money for non-qualified expenses.

 

 

Treasury Direct account 

If you’d like to gift savings to your grandchildren in the form of Treasury securities, you could open a Treasury Direct account. It’s safe and convenient, but it may not offer the same returns or diversification opportunities as other investment options.

 

Pros: 

1. Safety: treasury securities are backed by the US government, making them one of the safest investments available.

2. Convenience: You can set up a treasury direct account easily online and manage the account online too.

3. Low fees: there are no fees to open or maintain the account. 

4. Tax advantages: Interest earned on treasury securities is taxed at the federal level and exempt from state and local taxes. 

 

Cons:

1. Low returns: treasury securities typically offer lower returns than other investments like stocks or bonds.

2. Limited investment options: You can only invest in treasury securities. 

3. Access: it can take time to find a buyer or seller of treasury securities so you may not be able to access cash quickly if you need to.

4. Complexity: setting up a Treasury Direct account is relatively easy, but understanding the nuances of treasury securities can be complex. You may find it difficult to explain to your grandchild.

 

Simple/Absolute trust account

A simple/absolute trust can be a good way to pass down assets to your grandchildren while maintaining control over how they’re used.  But there are some drawbacks to bear in mind.

 

Pros: 

1. Tax benefits: You can structure the trust in a way that minimizes gift and estate taxes. For example, the trust can be designed to take advantage of the annual gift tax exclusion (allowing gifts of up to $15,000 per year without triggering gift tax). 

2. Asset protection: Assets placed in a trust are protected from creditors and potential lawsuits.

3. Control: The trust allows you to specify how and when assets are distributed to your grandchildren. This means the assets can be protected and preserved till your grandkids are ready to benefit from them.

 

Cons:

1. Complexity: Setting up a trust can be complicated and expensive. Especially if there are multiple beneficiaries or complex assets.

2. Limited flexibility: You can’t change the terms of the trust once it’s established. So if your grandchildren’s circumstances change it could be tricky to accommodate these.

3. Maintenance costs: The trust requires ongoing maintenance including filing tax returns, paying trustee fees, and providing regular accounting to beneficiaries. 

 

What do I need to open savings accounts for my grandchildren?

To open a savings account for your grandchildren, you’ll typically need:

 

• Your grandchild’s social security number (SSN) 

• Your grandchild’s full name, birth date and contact information

• Your full name, contact information and SSN

• Proof of identity: your driver’s license or passport.

 

Some banks require an initial deposit to open a savings account. If you’re opening a UGMA/UTMA account you’ll need to provide documents to prove you are the account custodian. 

 

It’s a good idea to shop around and compare the features and fees of different savings accounts before choosing one for your grandchildren. Some accounts may have minimum balance requirements and monthly fees. 

 

What is the most tax-efficient way to save money for my grandchildren?

A 529 plan is one of the most tax-efficient ways to save for your grandchild’s education expenses. Or, if your grandchild earns an income, a ROTH IRA has tax advantages too.

 

 If you want to use the funds for something other than education, a UGMA/UTMA custodial account is taxed at the child’s tax rate, rather than yours. You can also give cash gifts to your grandchild of up to £16,000 a year without paying gift tax, making it a tax-efficient way to transfer wealth to your grandchild. 

 

How much can I save tax-free for my grandchild?

There are several ways to save tax-free for your grandchild. The amount you can save depends on the method you choose. Here are some options to consider:

• Annual gift tax exclusion: you can give up to $16,000 per year per grandchild without triggering gift tax. If you have two grandchildren, for example, you can give up to $32,000. If you have three, you can give up to $48,000, and so on.

• 529 Plan: Contributions to a 529 plan grow tax-free. Withdrawals made for qualified education expenses are also exempt from tax. While there’s no annual contribution limit, there is a lifetime contribution limit that varies by state.

• Coverdell ESA: Contributions and withdrawals for education expenses are tax-free. The contribution limit is $2,000 per grandchild per year.

• UGMA/UTMA Custodial Account: There is no annual contribution limit but earnings on the assets are taxed at your grandchild’s tax rate. Check IRS rules for taxes on under-18s’ investment and other unearned income.

Bear in mind that while contributions may be tax-free, they may still be subject to other taxes or penalties. Consider the pros and cons of each option and choose the one that fits your financial goals and situation. 

 

Things to consider when opening a savings account for children

It’s important to shop around and compare different savings accounts before making a decision. Here are some things to consider:

• Amount and purpose: How much money do you plan to give? What types of investments are you going to use?

• Timeframe: Over what period of time are you planning to save and what’s the time frame for using the funds?

• Grandchildren’s involvement: How do you want to engage your grandchild in your investment? To teach wise investment habits you may want an account that offers more diversification.

• Account type: there are different types of savings accounts, including traditional savings accounts, money market accounts and certificates of deposit (CDs). Consider which one best suits your needs. 

• Fees and charges: Some savings accounts charge monthly maintenance fees or require a minimum balance. Look for accounts with low fees and charges to maximize your savings. 

• Interest rates: To help your savings grow, look for accounts with competitive interest rates. Are the rates offered fixed or variable? Decide which works best for you.

• FDIC insurance: Make sure the savings account is FDIC-insured. If the bank fails, your deposits are protected up to $250,000 per account. 

• Account access: Consider whether you want an account that allows online banking, or mobile banking. Online banks often offer better interest rates on savings accounts. Your grandkids are already familiar with phone apps and technology so they might find online banking more engaging. 

• Age requirements: Some savings accounts have age restrictions or require an adult to open the account on behalf of a minor. Check you understand what’s required before trying to open an account. 

• Deposit requirements: Some savings accounts require an initial deposit or ongoing minimum deposits to keep the account open.

• Withdrawal limits: Check if there are limits on the number of withdrawals or transfers you can make each month/year. 

• Tax implications: Some accounts, such as 529 plans or Coverdell ESAs, offer tax advantages for education expenses. Consider the tax consequences for you and your grandchild before opening an account. If your grandchild’s interest, dividends and other investment income combined total over $2,300 they may need to pay tax. Check the IRS’s rules. If a child’s only income is interest and dividends and totals less than $11,500 they may have to file a return. For more information read our article on income tax for under-18s.

How can I make sure my grandchild is responsible with the money I save for them?

Financial responsibility is a learned skill. It takes time and practice to develop. Here are some tips to help make sure your grandchildren are responsible with the money you save for them:

1. Start early: Money habits are set by age 7, so so the sooner you start teaching your grandchildren to be smart with money, the better. Set a good example by practicing good financial habits yourself.

2. Be clear about expectations: Let your grandchild know what the money is for and what you expect them to do with it. For example, if you’re saving for their education, tell them the money is solely for that purpose.

3. Keep control: Consider using a trust or custodial account to give you more control over how the money is spent. 

4. Talk openly and honestly: Keep lines of communication open and encourage your grandchildren to ask questions and seek guidance when making financial decisions. 

5. Provide guidance and support: Offer advice on budgeting, saving and investing to help with your grandchild’s financial education so they learn to manage their money. 

How can GoHenry help?

A prepaid kids debit card and app for 6-18-year-olds, GoHenry is a great way to help teach your grandchildren financial responsibility. Through Money Missions, kids can learn about saving, budgeting and a host of other topics. All through fun, bite-sized interactive games and videos.

 

What’s more, GoHenry makes it easy for family members to participate in children’s financial learning. Because you can add family members as GoHenry Relatives you can send money to your grandchild whenever you choose.