What is the best way to give grandchildren money?

As a grandparent, one of the most fulfilling experiences is the ability to financially support your grandchildren, whether it’s for their education, special occasions, or simply to give them a head start in life.

This article offers a guide through the different methods of giving your grandchildren money, their pros and cons, and the tax implications involved, so you can make an informed decision that benefits both you and your grandchild.

Can grandparents gift money to grandchildren?

Yes, grandparents can certainly gift money to their grandchildren. From a financial standpoint, various options are available, including custodial accounts, trust funds, Roth IRAs, savings bonds, and 529 plans. Each comes with its own set of rules and tax implications. For instance, as of 2023, you can gift up to $17,000 per grandchild per year without incurring any gift tax.

Additionally, direct payments for educational or medical expenses are exempt from these limits. However, it’s crucial to consult a financial advisor or tax professional to understand the full scope of your gifting options and any potential tax liabilities.

How to give money to grandchildren?

Custodial accounts

One of the most straightforward and adaptable methods for gifting money to grandchildren is through a UGMA (Uniform Gifts to Minors Act) custodial account. This type of account serves as an investment platform that an adult, often a grandparent, can establish for a minor. As the account’s custodian, you’ll oversee the assets and make investment decisions until the child reaches the age of majority — either 18 or 21, depending on state laws.

What sets custodial accounts apart is their tax advantage. Since the assets in the account legally belong to the child, any income generated — be it through compound interest or dividends — is subject to the child’s lower tax rate, up to a certain limit. This is commonly known as the “Kiddie Tax,” and it can significantly alleviate a family’s overall tax liability.

Another perk of custodial accounts is the absence of contribution limits. While you can contribute as much as you’d like, it’s essential to be mindful of the above-mentioned $17,000 annual Gift Tax exemption to avoid potential tax implications.

Trust fund

Trust funds offer another avenue for grandparents interested in gifting money to their grandchildren. Essentially, a trust fund is a legal entity created to hold assets until predetermined conditions are met, at which point the assets are transferred to the beneficiary. Trust funds are often used to minimize inheritance tax, thereby preserving the estate’s value for future generations.

One of the primary advantages of a trust fund is the level of control it provides. You can set specific conditions, such as releasing funds only when the grandchild turns 30 or restricting the money for educational expenses like college tuition or student loans. This gives you significant influence over how, when, and where the funds are utilized.

However, trust funds come with their own set of challenges. The setup process is complex, often requiring legal assistance, and involves ongoing management fees. Additionally, beneficiaries may still be liable for capital gains tax on any profits generated within the trust.

Roth IRA and saving bonds

Traditional financial instruments like Roth IRAs and savings bonds still hold value when it comes to gifting money to grandchildren. A custodial Roth IRA offers a tax-advantaged way to invest funds for your grandchild, with the account becoming accessible when they turn 18. This can be an excellent way to instill the importance of retirement savings from a young age. 

On the other hand, Series I savings bonds are a secure and straightforward option, backed by the U.S. government. These bonds can be particularly beneficial if used for educational expenses, as the gains are tax-free when used for this purpose.

529 plan

A 529 college savings plan is another specialized avenue for grandparents looking to financially support their grandchildren’s education. These tax-advantaged accounts are specifically designed to help families save for future educational expenses. The money invested in a 529 plan grows tax-free at the federal level, offering a significant financial benefit.

However, the tax advantages come with strings attached. The funds must be used for “qualified education expenses” to maintain their tax-free status upon withdrawal. Using the money for other purposes, like buying a car or off-campus housing, triggers taxes and a 10% penalty. This restrictiveness is why some families opt to pair a 529 plan with a more flexible UGMA custodial account.

Additionally, if your grandchild decides not to pursue higher education, the money in the 529 plan becomes taxable, and you’ll also incur a penalty. Therefore, while a 529 plan can be an excellent tool for educational savings, it’s essential to consider its limitations.

Education and medical bills

An often-overlooked gifting option is directly paying for a grandchild’s educational or medical expenses. There’s no limit on these types of gifts, and they’re separate from the annual $17,000 gift exemption for 2023. The key requirement is that payments must be made directly to the educational institution or medical provider.

How much money can you give to your grandchildren tax-free?

Understanding the tax implications is a crucial first step when considering the best way to give money to grandchildren. The U.S. tax code, governed by the Internal Revenue Service (IRS), sets specific limits on tax-free gifting, commonly known as the IRS Gift Tax exemption or Gift Tax limit.

Originally, the Gift Tax was instituted to prevent people from circumventing estate taxes by transferring their assets before death. Today, any financial gift exceeding the annual Gift Tax exemption is subject to taxation.

As of 2023, the annual Gift Tax limit is set at $17,000 per recipient. This means you can give up to $17,000 to each of your grandchildren in a single year without having to report it to the IRS. 

If you’re married and file taxes jointly, the annual limit doubles. For example, in 2023, a married couple could gift $34,000 to each grandchild, child, niece, or nephew without incurring any Gift Tax or even having to report these gifts.

Beyond the annual limits, there’s also a lifetime Gift Tax exemption, which stands at $12.92 million as of 2023. Exceeding this lifetime limit would necessitate paying taxes on any future gifts.