Q: What is the best investment gift that I can give to my 19-month-old granddaughter? – L. Gutierrez
A: Whether you have $100 to give or $10,000, the best investment gift for a young grandchild is to open or contribute to a tax-advantaged 529 college savings plan.
“For grandparents who want to help their kids pay for college, these make the most sense,” says John Gajkowski, a certified financial planner and co-founder of Money Managers Financial Group, in Oak Brook, Ill. “You have a broad range of choices of where and how you invest, and you can maintain control if you wish.”
More importantly, your investment grows sans tax, and qualified withdrawals—for things like tuition, fees, and room and board for higher education—aren’t subject to state or federal tax. Some states offer a tax deduction to boot if you go with your home-state plan.
Meanwhile, saving money in a 529 plan will have a minimal impact on financial aid. By contrast, if you were to put money in a traditional investment account in your granddaughter’s name, those sums would be factored into the family’s expected contribution.
Should your granddaughter get a full scholarship to college, no worries. You can just name another person as the beneficiary—they can be any age and needn’t be related.
If you must cash out, you will have to pay a 10% penalty, plus federal and state tax, on any earnings. This shouldn’t be a deal breaker, says Gajkowski. The advantages of socking away money in a 529 plan outweigh the risk that you won’t use the funds for higher education.
There are a couple of ways to go about making a contribution to a 529 account. The first is to open a 529 account in your name—you would serve as the custodian—and designate your granddaughter as the beneficiary. The advantage of going this route, says Gajkowski, is control. You can control how the money is invested, and you can change the name of the beneficiary at any time.
Option 2 is to help your granddaughter’s parents open their own 529, and make contributions to their plan. While you’ll give up control, this is a great way to get buy-in from your adult children—and get other relatives on board.
“We’ve had a lot of clients offer matching benefits to their [adult] children to incentivize them to save,” Gajkowski adds. “You can spread the word and let people know there is a general pool for college savings.”
While 529s are sponsored by individual states, you can invest in any state’s plan. In other words, if you don’t like the options or fees of your home-state plan, you can go with any state’s plan—and the money can be used for higher education in any state.
Start by seeing how your state plan sizes up against other states.
If your state allows for an income tax deduction (it’s typically capped at a few thousand dollars) and has a solid plan, that’s a good starting point. “But I would be far more concerned about the performance of the portfolio than any state tax benefit,” says Gajkowski, who recommends looking at the overall fees, investment options and track record.
If your state’s plan gets poor reviews, shop around for the best direct-sold non-resident plans at SavingForCollege.com. Most advisers recommend going with an age-based investment option, which will invest fairly aggressively when your child is young and gradually get more conservative as college approaches.
Your contributions are subject to the gift tax, though you can gift an individual up to $14,000 ($28,000 for couples) a year without running into that limit. You can also contribute up to $70,000 ($140,000 for couples) in one year and claim it over a five-year period.
The lifetime maximum contribution limits on most plans range from $200,000 to $350,000 per beneficiary. As college tuition trends higher, so are these saving ceilings.