Our children and grandchildren will likely be our most lasting legacy. We want to see them thrive—and we're often tempted to shower them not only with our love and attention, but also with any extra money we have. But this spirit of generosity can have its pitfalls.
If you have money to spare and a grandchild you want to spend it on, what's the best use of your money? Start by asking the parents how you can help. You should find out what they think their child lacks—and respect their preferences.
If your grandchild was recently born, you may find that the parents are looking for clothes, a car seat, toys, furniture—and perhaps some of your time, so they can get a break from child-rearing duties. But the parents may also want assistance with longer-term goals, notably college costs. If you can afford to help, that's great—but don't do so at the expense of your own retirement.
As you ponder ways to help your grandchildren and their parents, here are some strategies to consider.
• Make a gift. In 2013, you can give up to $14,000 to as many people as you like without worrying about the gift tax. For instance, a grandfather and grandmother could together give $28,000 to a new grandchild, as well as $28,000 to each of the baby's parents.
• Pay medical expenses. If a parent is out of work and without health insurance, a grandparent can pay the family's medical and dental expenses, as well as insurance premiums, without worrying about gift taxes or using the annual gift-tax exclusion. The payments must be made directly to the providers of these services or to the insurance company. Direct payments for educational expenses are also exempt from the gift tax.
• College, college, college. Paying for college is possibly the No. 1 financial concern for many parents. There are several ways to save for college, including savings bonds, Coverdell Education Savings Accounts and mutual funds in Uniform Transfers to Minors Act accounts. But for grandparents, 529 college savings plans deserve special attention.
Earnings in 529 plans are exempt from federal taxes as long as the money is used to pay for tuition and other eligible college expenses. You could invest as much as $70,000 in a single year in a grandchild's 529 plan and count it as your gift for the next five years, and your spouse could do the same. This would remove a large sum from your estate, as well as any subsequent investment growth this money might generate. One warning: If you elect to treat a gift as being made over five years and you die before the end of that five-year period, that portion of the gift that was allocated to the period after your death would be included in your estate.
If you are listed as the owner of the 529 plan, you control the assets, which means the money won't be at risk if, say, your grandchild's parents later divorce. Indeed, if you later discover you need the money in the 529 for yourself, you might even be able to take the money back, though that would likely trigger income taxes and tax penalties. Before doing so, you should consult with a tax professional.
• Consider trusts. There are a variety of trusts that grandparents can use to benefit their grandchildren. These trusts might be created upon your death, or—if you are confident you won't need the money for yourself—you might set up trusts while you are still alive.
One choice is an irrevocable life insurance trust. Here's how it works: You create a trust for your grandchild, and the trust purchases an insurance policy on your life. Your annual gift pays the premium and also shrinks your taxable estate. Because the trust is irrevocable, it can't be changed. You will need an attorney who specializes in estate planning to help you set it up.
• Know your limits. Make sure you can afford whatever sums you plan to spend on your grandchildren. Are you confident you are on track for retirement and your other financial goals? Your children and grandchildren will no doubt appreciate your generosity—but they may not be nearly so appreciative if it means they later have to provide you with financial help.
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Since life insurance is medically underwritten, you should not cancel your current policy until your new policy is in force. Your actual premiums may vary from any initial quotation you receive. A change to your current policy may incur charges, fees and costs. A new policy will require a medical exam. Surrender charges may be imposed, and the period of time for which the surrender charges apply may increase with a new policy. You should consult with your own tax advisors regarding your potential tax liability on surrenders.
You should consider the investment objectives, risks, charges and expenses of any 529 Plan Investment Options carefully before investing. This and other information is contained in the 529 Plan Disclosure Document, which should be read carefully. Before investing, you should read the Plan Disclosure Statement carefully and consider whether your state of residency—or your intended Designated Beneficiary's state of residency—offers any benefit, such as a state tax deduction, which is only available for investments in that state's 529 savings program.
Note: The 529 donor must be alive on January 1 of the year for which they claim the annual gift tax exclusion or that portion of the contribution must be added back to the donor's estate for determining the taxable estate.
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