Thinking About Giving Money to Your Grandchildren? Read This First

Seeing those giant smiles your grandchildren give you as they open the perfect gifts is one of life’s greatest pleasures. After all, spoiling the grandkids rotten is one of the main benefits of being a grandparent (that, and getting to have all the fun without the parental responsibility).

Yet kids today seem to have it all: toys, tablets, sports equipment. Instead of giving them more things to cram into their home, you may be thinking about giving money instead.

Although financial gifts can be a great way to provide for your grandchild’s future, in some cases your generosity could have unintended tax consequences—or create friction with the child’s parents. Here’s what you should know before you start giving to your grandchildren.

Ask first

It can be fun to see the delight on someone’s face when you surprise them with a present. But keep in mind that a financial gift with long-term impacts may not be welcomed if it comes out of the blue. By asking your child (and your child’s spouse) how they feel about the gift, you’ll be able to align with their savings strategies and values. They might have firm plans about how much money they want their kids to have and when, or it’s possible they are already saving for certain expenses but would want help with another.

Understand the gift tax rules

In 2023, you and your spouse can each give up to $17,000 per person to as many people as you’d like per year, according to IRS guidelines on gift exclusions. If you want to give more, you can, but that amount would cut into the $12.92 million ($25.84 million per couple) you’re allowed to give away without paying gift or estate taxes during your lifetime or at death. You’ll also have to file a gift tax return for any year in which you make a gift that exceeds the annual gift exclusion amount.

Choose your method carefully

You can always give cash. But if you want growth potential or for the gift to be used for a specific purpose, opening a specific account might be a better option. Here are some possibilities:

• 529 plan. A 529 plan is one of the most popular ways to save for college; it can be used for elementary or high school tuition. All 50 states and the District of Columbia sponsor a plan, so no matter where you live in the U.S. (and as long as you’re a citizen), you can save in any state’s plan. All contributions grow tax-deferred, and the earnings can be withdrawn tax-free as long as it’s for qualified expenses such as tuition, books, supplies and other costs.

• Coverdell education savings account. Another option if you’re looking to help pay for college for a child is to open a Coverdell account. With this savings vehicle, contributions can grow and be distributed tax-free as long as the money withdrawn is used for qualified education expenses. However, contributions are capped, and gross income must be under a set limit.

• Life insurance. A whole life insurance policy on a child can provide protection now and also in case the child develops a health condition that would make it hard for them to get insurance in the future, when there’s a greater need for it. The policy will also build cash value, which is money the policy owner could take a loan against for any reason (like making a down payment on a house or paying for a wedding).

• An irrevocable life insurance trust (ILIT). Putting a life insurance policy into an irrevocable life insurance trust can be a powerful legacy protection and estate tax planning strategy. Creating an ILIT to house a life insurance policy ensures that the policy proceeds will fall outside the taxable estate. A trust can also be especially effective if you’ve got family dynamics that may result in wanting to creatively distribute funds (such as in situations with blended families, second marriages, stepchildren and stepgrandchildren). Placing controls on when and how beneficiaries receive policy proceeds makes an ILIT a useful tool for taking into account family dynamics and the ages and specific needs of the intended recipients.

• Individual retirement account (IRA). IRAs are a great way to help your grandchildren get a jump on retirement savings. This includes both traditional and Roth IRAs. Naming your grandchildren as your beneficiaries on your retirement account(s) allows those funds, as long as they remain invested, to grow tax-free. Required minimum distributions on inherited IRAs differ depending on current policy, so be sure to ask your financial advisor for details on distribution requirements.

• UTMA or UGMA Account. A Uniform Transfer to Minors Act (UTMA) or Uniform Gifts to Minors Act (UGMA) account is opened in the name of the child and governed by state law. However, an adult (likely you or the child’s parents) keeps control of the account until the child reaches a certain age: between 18 and 21, depending on the state they’re in. The money in these accounts can be used on anything for the child.

• A combination of products. Depending on how much you’re looking to give and how often, it could make sense to gift money using a combination of savings and investment vehicles. Discussing your family succession goals with a financial planner can help you arrive at a recommendation that best follows your wishes.

Use a financial advisor to set up the giving structure

As you develop your gifting strategy, consulting a financial planner can be especially helpful in guiding you toward decisions that avoid generation-skipping tax rules or exceeding gift tax exemptions. Otherwise, you might find yourself paying upward of a 40-percent tax rate on those funds.

No matter how you choose to give, a financial gift for grandchildren—especially when they’re young—can go a long way toward setting them up for a solid financial future.

This publication is not intended as legal or tax advice. Northwestern Mutual or its financial representatives do not give legal or tax advice. Taxpayers should seek advice based on their particular circumstances from an independent tax advisor. Utilizing the cash value through policy loans, surrenders, or cash withdrawals will reduce the death benefit; and may necessitate greater outlay than anticipated and/or result in an unexpected taxable event.