Chris Farrell: Lots of options for gift to granddaughter

Q: We have been saving money on a monthly basis for our 4-year-old granddaughter’s education. The account pays a modest return. We are interested in investment options. What options do you recommend: stocks, mutual funds, CDs, savings bonds? Should the investments in our names or hers.

Greg

 

A: I think it is wonderful that you’re setting money aside for your granddaughter. The core of my answer is the best way to figure out how to invest and manage the money is to decide what you’re trying to accomplish with the savings. Here’s an example of what I mean.

Let’s say your primary goal is paying for college. In that case, one of the best options for grandparents is to fund a 529 college savings plan. Your contributions to the account are with after-tax dollars, but the money compounds tax-sheltered and withdrawals are tax-free so long as the money goes into qualified college education expenses at an accredited institution. You control the account and the investments. Grandparents can put in up to five years’ worth of annual gifts of up $14,000 at once without paying gift taxes (that adds up to $70,000 per grandparent, per beneficiary). The financial aid impact of a 529 is minimal. The account is treated the same as parental assets in the Expected Family Contribution (EPC) calculation up to 5.6 percent of assets. That compares to 20 percent for a student’s savings. The investment choices in many 529s are broad-based stock, bond and cash funds.

Alternatively, you could establish a Coverdell education savings account. It shares some of the benefits of a 529, but the money is available for K-12 education expenses, as well as postsecondary schooling. The annual ­contribution to a Coverdell is $2,000 and there are income limits.

Now, let’s say your primary goal is to teach your granddaughter about the markets when she’s a few years older. In that case, rather than opening a 529, I would set up a custodial account for her. These accounts, which permit gifts to minors, allow a minor to own securities, but you control the account until she reaches age of majority (18 years in Minnesota). This kind of account is ideal for teaching about investing. Whatever her passions and interests, she’ll find there are plenty of public companies to research and invest in. She may or may not make a profit picking stocks, but that isn’t the goal. Instead, you want her to absorb lifelong lessons about the markets.

That said, these custodial accounts are not as good a way to save for college compared to a 529. For one thing, the money is hers when she’s 18. If she decides to spend it on travel or opening a restaurant rather than on college, it’s her choice, not yours. Also the financial aid system considers the account a student asset, so it is usually counted at the 20 percent of expected family contribution rather than the up to 5.6 percent for parental assets.

You could also continue what you’re doing in your name — investing in a taxable account. It’s your money. You can help out with the college bills from this account when the time is right. If your financial circumstances take a turn for the worse or she doesn’t need the money for college, you can always spend the savings on yourself. One way to decide how to invest the money is to understand what her parents are doing with their savings. If they’re taking greater risks with their money, you might want to invest conservatively to backstop their portfolio, and vice versa.

 

Chris Farrell is economics editor for “Marketplace Money.” His e-mail is cfarrell@mpr.org.

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