What Is the Best Account to Open for a Grandchild?

Financial options for a grandchild’s future can provide a foundation for their success. Many seek to contribute to a grandchild’s education, general financial well-being, or early retirement savings. Understanding various financial accounts helps select the most suitable option for these goals. Each offers distinct advantages and considerations regarding control, taxation, and accessibility.

Education-Focused Savings Plans

Educational savings accounts offer tax advantages for qualified expenses. Two options are 529 plans and Coverdell Education Savings Accounts (ESAs). These plans provide tax benefits on growth and withdrawals.

A 529 plan is a state-sponsored investment account where contributions grow tax-deferred. Withdrawals are tax-free when used for qualified education expenses. Qualified expenses include tuition, fees, books, supplies, room and board at eligible post-secondary institutions, and up to $10,000 per year for K-12 tuition. The account owner, typically the donor, maintains control, including changing the beneficiary.

There is no federal annual contribution limit, but states impose lifetime limits per beneficiary. Contributions are considered gifts for tax purposes; individuals can contribute up to $19,000 in 2025 per beneficiary without incurring federal gift tax, or $38,000 for married couples. A unique “superfunding” feature allows up to five years of contributions ($95,000 in 2025) to be made at once, provided no additional contributions are made for the subsequent four years. If funds are withdrawn for non-qualified expenses, the earnings portion is subject to federal income tax and a 10% federal penalty.

Coverdell ESAs offer tax-deferred growth and tax-free withdrawals for qualified education expenses. They have a broader definition of qualified expenses, covering both higher education and elementary/secondary school costs like tuition, books, and technology. Unlike 529 plans, Coverdell ESAs have a strict annual contribution limit of $2,000 per beneficiary.

Contribution eligibility is subject to income limitations; for 2025, it phases out for single filers with modified adjusted gross income (MAGI) between $95,000 and $110,000, and for married couples between $190,000 and $220,000. Funds must be used by age 30 or rolled over to an eligible family member to avoid taxes and penalties. Non-qualified withdrawals from a Coverdell ESA are subject to income tax on the earnings portion and a 10% federal penalty.

General-Purpose Custodial Accounts

For general financial support, custodial accounts under the Uniform Gifts to Minors Act (UGMA) or Uniform Transfers to Minors Act (UTMA) offer flexibility. These accounts involve an irrevocable asset transfer to the minor, managed by an adult custodian until the child reaches the age of majority. The minor legally owns the assets, which are theirs to use without restriction once they gain control.

UGMA and UTMA accounts differ in asset types they can hold. UGMA accounts are limited to financial assets like cash, stocks, and bonds. UTMA accounts allow a broader range of assets, including real estate and other tangible property. Most states have adopted UTMA, which allows for a broader range of assets than UGMA.

There are no contribution limits, but contributions exceeding the annual gift tax exclusion ($19,000 per donor per beneficiary in 2025) may require a gift tax return. Assets are taxed at the minor’s rate. Unearned income above a certain threshold may be subject to “kiddie tax” rules, taxed at the parent’s marginal rate. The minor gains full control upon reaching the age of majority, typically 18 or 21.

Retirement Savings for Minors

A Custodial Roth IRA offers a unique opportunity for early long-term retirement savings, capitalizing on compounding. It is an individual retirement arrangement held by a minor but managed by an adult custodian until the child reaches the age of majority.

A Custodial Roth IRA requires the minor to have earned income from wages or self-employment, like babysitting. The 2025 annual contribution limit is the lesser of the minor’s earned income or $7,000. Contributions are after-tax, and funds grow tax-free, with qualified withdrawals in retirement also tax-free.

Original contributions to a Roth IRA can be withdrawn at any time without taxes or penalties. Earnings withdrawals are tax-free and penalty-free after five years and reaching age 59½, becoming disabled, or for specific qualified expenses like a first-time home purchase or higher education. The custodian manages investments until the minor reaches the age of majority, typically 18 or 21, when full control transfers.

Factors Guiding Your Decision

Choosing an account involves considering key factors based on your intentions and the grandchild’s needs. These help align financial contributions with desired outcomes. Understanding each account’s implications on control, taxation, and accessibility is important.

The primary purpose of funds should influence account selection. For education expenses, 529 plans or Coverdell ESAs offer significant tax advantages. For general financial support, like starting a business or purchasing a home, a custodial account (UGMA/UTMA) provides greater spending flexibility. For long-term wealth building and retirement, a Custodial Roth IRA leverages early compounding and offers tax-free growth.

Control over funds is an important factor. With 529 plans, the donor typically remains the owner, maintaining control over distributions and beneficiary changes. UGMA/UTMA funds become the minor’s irrevocable property, managed by a custodian until the age of majority, when the grandchild gains full control. Custodial Roth IRAs also transfer control to the beneficiary at the age of majority.

Tax implications for both donor and beneficiary are important. 529 plans offer tax-deferred growth and tax-free withdrawals for qualified educational expenses; some states provide tax deductions. Coverdell ESAs provide tax-free growth and withdrawals for qualified expenses, but have income limitations. UGMA/UTMA accounts are taxed at the minor’s rate, though “kiddie tax” rules may apply to unearned income. Custodial Roth IRAs are funded with after-tax dollars, providing tax-free growth and withdrawals in retirement, benefiting a young person’s future earnings.

Financial aid eligibility for higher education is a concern. Parent-owned 529 plans are treated favorably on the FAFSA, counted as a parental asset with a low impact on aid eligibility. Grandparent-owned 529 plans also have a reduced impact, as withdrawals no longer count as student income on the FAFSA starting 2024-2025. UGMA/UTMA accounts are student assets, assessed at a higher rate, potentially reducing aid eligibility. Custodial Roth IRAs generally do not impact federal financial aid unless withdrawals for college expenses count as income.

Evaluating contribution and withdrawal flexibility is important. 529 plans offer high contribution limits and “superfunding” for larger gifts. Coverdell ESAs have a lower annual contribution cap and income restrictions. UGMA/UTMA accounts have no contribution limits, but the gift is irrevocable, meaning funds cannot be reclaimed. Roth IRA contributions can be withdrawn without penalty, but earnings withdrawals have specific rules for tax-free and penalty-free access before retirement.