Gifting to Grandchildren

By Jeanne Blackmore, Esq

Clients often ask our recommendations for the best way to make meaningful financial gifts to grandchildren. The end of the year is a great time to consider this type of gifting, as it should be done hand in hand with other financial planning. As with all gift planning, you should make gifts only after you confirm that you have adequate assets for yourself for the remainder of your lifetime.

The great thing about implementing a gifting program for grandchildren is that, if you start when they are young, there is a lot of time for gifted assets to accumulate and appreciate. There are several ways to structure a gifting program to be tax efficient, even tax-free, so that growth over time is maximized. As with all planning, what gifting program would work best for you depends on the particular facts and circumstances of your family. That said, here are our favorite gifting structures for grandchildren:

529 Plans

A 529 Plan is a special type of savings account that provides tax-free growth provided the assets in the Plan account are used to pay for the education of the beneficiary. 529 Plans are governed by federal law but are administered by states. All states (except Wyoming) have a 529 Plan, and each state plan has a different maximum funding level for a Plan account. States often offer benefits for state residents for using a state Plan, such as state income tax credits or matching contributions, but you can use the Plan of any state.

Attractive features of 529 Plans are:

• A grandparent may make 5 years of annual exclusion gifts to a 529 Plan in one year. For 2023 and 2024, 5 years of annual exclusion gifts is $85,000 and $90,000, respectively.
• If one grandchild doesn’t use all the assets in a Plan account, the Plan account can be transferred to another family member.
• Starting in 2024, a one-time transfer of up to $35,000 of Plan assets to a Roth IRA is permitted under certain circumstances.

There are two main drawbacks to 529 Plans. First, if a grandchild doesn’t attend college or doesn’t need funds to pay for college, 529 Plan earnings are subject to income tax plus a 10% penalty if withdrawn for non-educational purposes. Second, 529 Plan account investment options are limited to what is offered by the Plan custodian selected by a state.

Crummey Trust

A Crummey Trust is a special kind of trust that allows gifts to the Trust to be eligible for the annual exclusion. Most people like to make sure that a gift qualifies for the annual exclusion otherwise the gift will reduce the Donor’s available federal estate tax exemption. Generally, a gift qualifies for the annual exclusion only if it is a gift of a present interest, and a gift to a trust is typically a gift of a future interest. However, a properly structured Crummey Trust includes a provision requiring the Trustee to notify the beneficiary that he or she may remove an annual exclusion gift for a short period of time after the gift is made. Thus, unless the annual notice requirement is problematic for a particular grandchild, a Crummey Trust is a great vehicle for making annual exclusion gifts for a grandchild. Married grandparents could make annual exclusion gifts to a Crummey Trust over a period of 10 or more years without using any estate tax exemption. The Trust terms may provide for distributions to be made to the grandchild for any number of purposes including, but not limited to, education. In addition, the Trust could last for as long as is desirable – until the grandchild is 25 or 65 years old or anywhere in between. Finally, a Crummey Trust could be structured as a so-called “grantor trust.” This means that the grandparent(s) who created the trust would be treated as owning the trust assets for income tax purposes and would pay income tax on the interest, dividends and capital gains earned by the trust. This may sound unappetizing but allows the trust assets to grow free from reduction for income taxes. For grandparents with state or federal taxable estates, this can have the happy side effect of reducing the grandparent’s estate without any use of exemption.

The main advantage of a Crummey Trust is flexibility. For example, the trust assets may be used for purposes other than education and are not subject to restricted investment options, unlike the 529 Plan. The disadvantage of a Crummey Trust is that it does not offer the tax-free growth of a 529 Plan, and the annual notice requirement can be impractical or an administrative hassle. Because the Crummey Trust and the 529 Plan both have significant benefits, some families will use both a Crummey Trust and a 529 Plan if the overall circumstances make it feasible.

2503(c) Trust

A 2503(c) Trust serves the same purpose and has the same general structure as a Crummey Trust. However, by legislative grace, in the case of a 2503(c) Trust, it is not necessary to provide notice of gifts to qualify for the annual exclusion. Rather, the beneficiary must be notified of his/her temporary right to withdraw the trust balance at age 21 and, if the beneficiary does not withdraw the trust balance within a short period of time, then the trust continues according to its terms. Apart from the different mechanisms for qualifying for the annual exclusion, a 2503(c) Trust may be structured with the same flexibility as a Crummey Trust and offers the same advantages and disadvantages as a Crummey Trust. Since the annual notice requirement is an administrative burden, a 2503(c) Trust is a popular alternative to a Crummey Trust.

Please be in touch if you would like additional information regarding any of these gift strategies.