How to Invest for Your Grandchildren

Investing for grandchildren offers a way to contribute to their future, whether for education, starting a business, or purchasing a home. These long-term investments can grow over time, providing a financial foundation for future generations. Understanding investment avenues is important for informed decisions.

Custodial Accounts

Custodial accounts, established under the Uniform Gifts to Minors Act (UGMA) or the Uniform Transfers to Minors Act (UTMA), provide a method to gift assets to a minor. An adult, the custodian, manages the assets for the minor beneficiary. The assets legally belong to the child, but the custodian maintains control until the child reaches the age of majority.

The age of majority, when assets transfer to the grandchild, typically ranges from 18 to 21, depending on the state. Once the grandchild reaches this age, they gain full control over the funds, with no restrictions on how the money can be used.

Investment income generated within UGMA/UTMA accounts is subject to “kiddie tax” rules. Unearned income exceeding a certain threshold is taxed at the parents’ marginal tax rate.

529 Plans for Education Savings

529 plans are savings vehicles designed for education expenses, offering tax advantages. Contributions are typically made with after-tax dollars; they are not federally tax-deductible. However, earnings grow tax-deferred, and qualified withdrawals for eligible education expenses are federal income tax-free.

The account owner, usually the grandparent, retains control over the funds, including the ability to change the beneficiary. Qualified expenses include tuition, fees, books, supplies, equipment, and room and board for eligible educational institutions. Up to $10,000 annually can also be used for K-12 tuition expenses per beneficiary.

Two types of 529 plans exist: college savings plans and prepaid tuition plans. College savings plans invest contributions in various portfolios, with returns fluctuating based on market performance. Prepaid tuition plans allow the purchase of future tuition credits at current prices, locking in tuition costs. Many states offer their own 529 plans, and many provide state income tax deductions or credits for contributions.

Trust Accounts and Other Options

Trust accounts offer a method for investing for grandchildren, providing control over how and when assets are distributed. A trust allows the grantor to establish specific terms for asset management and disbursement, ensuring funds are used according to their wishes. Establishing and maintaining a trust can involve legal complexities and costs, making them suitable for substantial gifts or intricate distribution requirements.

Direct cash or securities gifts are common. The annual gift tax exclusion allows individuals to gift up to $19,000 per recipient in 2025 without incurring gift tax implications or affecting their lifetime gift tax exemption. For married couples, this effectively doubles to $38,000 per recipient per year. Any amount exceeding this exclusion would reduce the donor’s lifetime gift tax exemption, which is $13.99 million per individual for 2025.

Another option, if the grandchild has earned income, is contributing to a Roth IRA on their behalf. A minor must have earned income from work to contribute to a Roth IRA. The contribution limit for a Roth IRA for kids in 2025 is $7,000 or the total annual earned income, whichever is less. While primarily a retirement account, contributions can be withdrawn tax-free at any time, offering flexibility for future needs.

Important Decisions When Investing

Choosing an investment vehicle involves considering control over funds and when the grandchild gains access. UGMA/UTMA accounts give the grandchild full control at the age of majority. A 529 plan allows the account owner to retain control indefinitely, and a trust can specify distribution conditions.

Financial aid eligibility is another factor, particularly for college savings. Assets in a student’s name, such as an UGMA/UTMA account, are assessed more heavily than parent-owned assets for need-based financial aid. Grandparent-owned 529 plans do not count as an asset on the Free Application for Federal Student Aid (FAFSA), nor are distributions treated as student income.

Gift tax considerations also play a role in investment planning. Contributions to 529 plans, custodial accounts, or direct gifts fall under annual exclusion rules.

The investment approach should align with the grandchild’s age and the investment timeline. For younger grandchildren, a growth-oriented strategy with higher equity allocation may be suitable due to the longer time horizon. As the grandchild approaches the time funds are needed, a more conservative approach, shifting to less volatile investments, can help preserve capital.