Close Close
Popular Financial Topics Discover relevant content from across the suite of ALM legal publications From the Industry More content from ThinkAdvisor and select sponsors Investment Advisor Issue Gallery Read digital editions of Investment Advisor Magazine Tax Facts Get clear, current, and reliable answers to pressing tax questions
Luminaries Awards

Life Health > Life Insurance

Investing for Grandchildren

Your article was successfully shared with the contacts you provided.

If you have clients who are grandmothers, chances are they’ll want to invest in their grandchildren. “Grandmothers are always looking to care for their grandchildren’s needs,” says Meladee Rudolph, senior consultant for Stryde Savings and co-founder of Acuvise Retirement Solutions. “It’s in our DNA – we can’t help it.”

College in particular, is where they’ll usually want to help – but those costs only continue to rise. According to the College Board, the average annual costs of attendance for 4-year institutions are $9,410 for students enrolled publicly in-state, $23,893 for out-of-state students and $32,405 at private schools.

Even for a well-to-do retiring woman, those costs can quickly cut into a nest egg, particularly when there are multiple grandchildren involved. Combine that with the costs of longevity, healthcare and long-term care, and well-meaning grandmothers can run the risk of sacrificing their own qualities of life – and perhaps even becoming dependent on the heirs they’re trying to help.

Fortunately, there are a few well-established ways clients can invest in their grandkids’ futures without putting their own retirements at risk. From 529 plans to the creative use of life insurance, if you’re advising today’s growing group of retirees, it’s important you understand the available strategies.

The 529 plan

One of the most popular ways to save, total assets in 529 plans reached $275.1 billion by the end of 2016.

“They’re very flexible, low-cost and either tax-free or tax-deferred, depending on the ultimate use of the funds,” says Leann Sullivan, vice president of TFC Financial Management.

Also known as qualified tuition plans, 529s are available in every state and the District of Columbia. They offer a few distinct tax benefits: Earnings aren’t subject to federal tax, withdrawals used for qualifying college expenses are tax-free and even non-qualified withdrawals only incur a 10 percent penalty on growth.

What’s more, contributions are considered gifts for tax purposes. Maximum contributions vary by state, but limits are typically based on total contributions per designated beneficiary. A single benefactor can contribute up to $70,000 in a five-year period, per beneficiary, without triggering the gift tax, and in some states, maximum account balances can reach $500,000.

A critical caveat: 529s in grandchildren’s names can come back to bite them.

“If the owner is the parent or student applying for aid, that has to be disclosed on the FAFSA [Free Application for Federal Student Aid], and it counts as assets when calculating the expected family contribution,” says Sullivan. “However, grandparents’ accounts don’t count.”

Still, if funds are withdrawn from a client-owned account to pay for a grandchild’s education, that amount will have to be reported on the following year’s FAFSA, reducing aid by up to 50 percent. That’s a moot point if the 529 is big enough to cover four years of tuition, room and board – but if it’s not, clients and their families will need to carefully time their withdrawals for maximum effect

Indexed universal life insurance

A popular alternative to the 529, a life insurance policy may be a better bet for some clients, particularly those want to help their grandchildren well beyond their college years.

“My ideal financial tool is an indexed universal life insurance policy,” says Rudolph. “Money can be taken out tax-free to pay off student loans, and if the policy is left with no further contributions after the child turns 35, it continues to grow in cash value because it’s indexed against the S&P 500.”

Funds are also withdrawn through the policy’s loan provision, and if they’re not “paid back,” the death benefit is simply altered – an attractive alternative to paying a penalty or tax. Withdrawals don’t have to be spent on education, either, and the policy is never included in financial aid calculations.

“It provides market opportunity without market loss,” Rudolph says. “During the crashes of 2000, 2001, 2002 and 2008, those policies slowed in growth, but they never lost their gains. When you consider the money also comes out tax-free, that’s another 30 percent of value added on.”

The downsides? Universal life is significantly more complicated than a 529, which is essentially a bucket of mutual funds akin to a 401(k) or IRA. Upfront and ongoing fees are also higher, and it may take 10 or more years for the cash value to surpass the premiums.

Even so, a life policy’s flexibility, growth potential and tax status make it an attractive option for clients planning well in advance. If the beneficiary is still in diapers when the client takes out the policy, they may have five or six figures waiting for them by the time they reach college.

Beyond college

Even if your clients’ grandkids don’t go to college – or if they just need some extra help afterwards – there are plenty of other ways to help them out.

“The best asset they can gift to kids or grandkids is cash or anything else high cost-basis, so they’re not passing on unrealized capital gains,” says Sullivan.

To that end, an individual can gift up to $14,000 tax-free per year. If a client and spouse each give a grandchild and their spouse that sum, that’s $56,000 per year the young couple can use to pay off debt and make a down payment on a home.

A life policy comes in handy here, as well. “Take a lump sum out of the policy at 26 to pay off college loans, and allow the rest to grow for another 10,” says Rudolph. “By that time, they might have another $30,000 to $50,000 available to pay off a mortgage or use as a down payment. This allows budgets not to be broken and retirements not to be destroyed.”

Financial education

Gifts aside, one of the best ways clients can help their grandkids is to help them become financially literate and responsible.

“Financial education of grandchildren is something that’s really important, and we’ve noticed these conversations are especially important with female clients,” says Sullivan.

Among millennials, 39 percent worry about their financial futures at least once per week, and only 50 percent pay their credit cards in full every month. Twenty percent haven’t started saving, either, and of the 80 percent who have, 59 percent have less than $5,000 in savings.

One way to encourage better habits while also giving grandkids a boost: “We’ve had clients match their teenage children’s accounts when they start working, making contributions to something like a Roth IRA,” says Sullivan. It’s never too early to save for retirement, after all, and a Roth is a great way for a grandchild to learn firsthand the impacts of compounding returns and interest. Plus, unlike a 529, a Roth won’t be reported on the FAFSA.

Securing intergenerational wealth

As is typically the case in financial planning, the earlier your clients plan for their grandchildren, the better. Insurance policies, 529s and custodial accounts need time to grow, and in general, longer-term options offer greater flexibility for both the benefactor and beneficiary.

“The outcome we’re all looking for is the same,” says Rudolph. “We want the money to be accessible, usable and able to grow without any losses along the way.”

Ultimately, by helping your clients and their grandchildren secure their futures, you’ll only solidify business with their heirs and increase your firm’s assets under management.


© 2024 ALM Global, LLC, All Rights Reserved. Request academic re-use from All other uses, submit a request to [email protected]. For more information visit Asset & Logo Licensing.