A savings account could mean a big financial boost for your grandchild.

 

If you’re a grandparent, chances are you’ve thought about how you can help your grandkids save for their future. And in many cases, it’s easier for grandparents than it is for parents of young children to put away money for the family’s youngest generation.

For one, as a grandparent you may have more available resources than your adult children, who must cover childcare costs and other child-rearing-related expenses. And in some cases, you may have more time on your hands to research and keep track of a new savings plan of some kind.

These days there are plenty of dependable options that will not only help your grandchild get a solid start toward their financial future but that also allow you to leave an important legacy.

When mulling which type of savings account to open for a grandchild, it’s important to consider how you want those funds to be used, says Jaime Quiros, CFP and portfolio managers at FBB Capital Partners. “The biggest question is what the grandparents are trying to save for, whether it’s for only for college or just for getting their grandkids a step ahead in life,” he says.

Let's take a look at four main types of savings accounts for grandchildren.

 

1. 529 plans

Since its creation by Congress in 1996, the 529 plan has become one of the most popular ways to save for college. Named for a section of the Internal Revenue Code, 529s have a lot of advantages. For one thing, this type of account grows tax-deferred, and many states offer state tax deductions for contributions to a 529, Quiros notes.

“It’s the most flexible plan because you can change beneficiaries if you need to,” he says. That means you can still remain the owner of the account and either use the money for yourself or transfer it to another loved one if your grandchild doesn’t need the money.

Cathy Curtis, CFP, and owner of Curtis Financial Planning, LLC, says that 529 plans can also be a good estate planning tool, because these accounts can be “super-funded,” meaning that you can contribute up to five years of gifts (at up to $14,000 per year or $70,000 total) without being taxed for them.

There are two main types of 529 plans:

  • Savings plans
With a 529 savings plan, you invest funds on behalf of a beneficiary. The interest earned on those funds is not taxable if used for qualified expenses such as tuition, fees, room and board, and books.
  • State prepaid tuition plans
This type of 529 plan locks into the current tuition rate of a public college or university. It can also be used to pay for private or out-of-state schools while receiving an amount equal to the average state tuition at the time of withdrawal.

 

2. Trust funds

A more traditional way for grandparents to pass down assets, trust funds are also among the best types of saving accounts for grandchildren. You can use many different types of assets to establish a trust, and you also get to determine how they’re used. The grandchild can legally access the money after turning 21.

“The benefit of a trust fund for education costs is that they can be very specific, the trustee is legally obligated to fulfill the wishes and access to the funds can be restricted to any age,” says Curtis.

The big disadvantage of trusts is how pricey they are – setting one up can run you anywhere from $1,500 to $5,000. And maintaining the trust can also be on the costly side, Curtis says, since income earned in the trust will be taxed at high trust tax rates.

 

3. Coverdell Education Savings Accounts

A Coverdell Education Savings Account (ESA) is an investment account that allows you to save money for your grandchild’s higher education costs. The money saved in these accounts is typically used toward college tuition, books, room and board and other related costs.

“Earnings in this type of account will grow tax-free and won't be taxed at withdrawal, and investments can be self-directed,” Curtis notes.

The main drawback is that there are limits to how much you can give each year -- contributors to Coverdell ESAs can save no more than $2,000 annually for grandchildren under 18.

Coverdell accounts are less flexible than other types of savings accounts – for one, the funds must be used for specific educational expenses or else the money withdrawn is subject to a 10 percent penalty. Additionally, you won’t be able to contribute to the account after your grandchild turns 18, and he or she has to use the funds before turning 30.

 

4. UGMA or UTMA Funds

The Uniform Gifts to Minors Act and Uniform Transfers to Minor Acts (UGMA and UTMA) are laws that exist in some states that let someone to make a gift of money, real estate, patents or other valuable assets to a child that he or she can later claim once they’re of age.

One benefit of these funds is that unlike the last option, the money doesn’t necessarily have to go toward college-related costs. And there are no limits on how much you can contribute to UGMA or UTMA funds, though there is a federal gift tax penalty on contributions of more than $14,000 per year from a single person (or $28,000 from a married couple). Plus, for grandkids under 19, the first $1,000 contributed to the account each year is untaxed, while the second $1,000 contributed will only be taxed at a “minor’s rate,” which is typically lower.

As with 529 plans, depending on the amount contributed, the funds in this account could have an effect on your grandchild’s eligibility for scholarships and other types of financial aid for college, Quiros notes.