Raising children has gotten to be a very expensive proposition.
Costs for health care, schooling, transportation, child care and myriad other items gobble up thousands of dollars every year. Indeed, the expense today reaches levels that an earlier generation--today's grandparents--never dreamed of.
And in some families, it is these grandparents who have amassed a good-sized nest egg and now have a few bucks to spare while the younger parents don't. Fortunately, assuming that the grandparents are willing, it is fairly easy for them to come to the aid of their grandchildren directly, and indirectly help their children.
"There are lots of things you can do," ranging from very simple to quite complex, depending on the amount of money involved, said Thomas C. Grzymala of Alexandria Financial Associates.
The easiest thing for many families is simply for the grandparents to give money.
Under current tax law, any individual can give any other individual up to $10,000 a year without the recipient or the donor paying taxes on it. This means that if both grandparents are alive, they can give each child and grandchild up to $20,000 every year without the child's having to pay taxes on the money.
This is more than enough to cover the needs of most families. If it is not, the law also allows for the payment of school tuition or medical costs by one person on behalf of another as long as the payment goes directly to the school or health care provider and does not pass through the hands of the beneficiary.
When grandparents want to provide assistance, it may make sense for the gifts to be in the form of stocks or mutual fund shares. Such a gift would still come under the $10,000 tax exempt limit. "If you can get some stock that the child can identify, Coca-Cola or Disney or something like that," the process can also begin the young person's financial education as well, Grzymala said.
Grandparents who opt for such presents often find it beneficial to establish what is called custodial accounts for minors, so that the parent or grandparent retains a measure of control over the investment until the child reaches legal age. Brokerages, mutual funds and banks are familiar with custodial accounts for minors and will provide forms to set one up.
Assets in custodial accounts are the property of the child and cannot be retrieved or used for the benefit of others, and they come under the control of the child when he or she reaches majority--age 18 in many jurisdictions. If the grandparents have doubts that grandchildren will use the funds responsibly or if very large sums are involved, they may prefer to establish a trust.
When someone establishes a trust, a written document--the trust--governs how the assets can be used. The funds are controlled by a trustee, who is responsible for distributing the assets according to those guidelines. Trusts are more costly to set up and administer, but they provide more controls on how the funds are used, said Cynthia Brown, an attorney with Frederick J. Tansill & Associates in McLean.
Another option that is becoming popular is funding individual retirement accounts for youngsters when they begin to earn their own income. Many teenagers work, but it's asking a bit much to get them to plunk their earnings into an IRA, especially since many of them need the money for school or expenses. But most teenagers are willing to set up an IRA if somebody else funds it.
The law allows people who meet certain standards to contribute up to $2,000 each year to an IRA and get a tax deduction for that amount. But even if grandparents funded the IRA for a grandchild, the deduction would go to the child. Since the children typically are in low tax brackets, any tax deduction they might get from a traditional IRA isn't very valuable.
A Roth IRA, which allows money to be taken out tax-free when they reach retirement age, may be more appealing. If $8,000 were set aside for a child in a Roth IRA ($2,000 annually for four years of summer jobs, for example), the account would provide more than $250,000 tax-free 45 years from now, assuming an 8 percent annual growth rate for that simple investment.
Just giving grandchildren cash, though, as an outright gift or to fund an IRA grates on a number of older people. For some, funding education is a different matter. In fact, said financial planner Alexandra Armstrong of Armstrong, Welch and MacIntyre Inc. in the District, "The most common thing [grandparents do] is paying for education."
"In the past," she said, "we always thought about it for college . . . but nowadays I see grandparents paying tuition directly or at least helping out" for private secondary or even elementary school.
Payment for tuition can be in addition to the $10,000 tax-exempt limit.
In addition to direct tuition payments, there are other ways to help with a grandchild's school costs.
The relatively new Education IRA allows $500 annually to be invested in a tax-deferred account; those funds are tax-free to the student when used to fund higher education expenses. To establish this type of IRA, the student does not need to be earning income.
However, there are strict rules about these IRAs. Contributions are not deductible, a single donor's income cannot exceed $110,000 ($160,000 on a joint return), and the $500 annual limit strikes some critics as too small for the trouble. Many advisers, though, reason that even a small benefit is better than none.
Other alternatives that may be attractive to grandparents are qualified state tuition programs. There are two basic types:
* Prepaid tuition plans (available in Maryland and Virginia), which promise to pay the tuition of a child at a public college in the state (or in some cases an amount equal to that if the child goes out of state or to a private college). These plans have no income limits and they remove the risk that tuition at public college will outrun the family's savings, but they have residency restrictions and do not cover room, board and other expenses.
* Education trusts, or so-called 529 plans, which are tax-deferred education investment accounts operated by a number of states. Most have no residency requirements and the money can be used at any college. They, too, have no income limits, and some allow contributions of $100,000 or more. The money is invested by an agency of the state or by a private contractor--Fidelity Investments, TIAA/CREF and Merrill Lynch are among the money managers that have gotten into this--and the proceeds can be used for any higher education expense, including books and room and board.
However, the trusts have no guaranteed return and management is done entirely by the state or the contractor. The donor has no control over the investments. Also, the proceeds are taxable to the student when withdrawn, although if the student has little other income that is not a serious problem.
Contributions to an education trust are treated as gifts to the student for purposes of the $10,000 annual limit, but a special provision allows a donor to contribute $50,000 at once and treat that as five years' worth of gifts.
Armstrong said that whatever vehicle grandparents choose, most feel it is money well spent. "Everybody feels education is so key to someone's future," she said.