Leaving a Legacy for Grandchildren: Options for Grandparents

Grandparents of means have several options for passing their wealth on to their grandchildren. The best option or combination of options for your situation depends on several considerations. Among them are the ages of your grandchildren, whether any have special needs or disabilities, whether college or post-secondary education is a viable option, and the gift and estate tax implications. This paper presents a brief introduction to several options for grandparents to reduce their gross estate while leaving a legacy for their grandchildren.

Current Gifts

Use the Annual Exclusion Amount

Making current gifts to grandchildren, directly or indirectly, can be a great strategy for helping them and their parents pay for necessary expenses and reducing your gross estate. In 2024, grandparents can gift up to $18,000 each to each grandchild without incurring gift tax or using any of their lifetime gift tax exclusion. Married couples can give up to $36,000 to each grandchild in 2024.

Grandparents can give more than the annual exclusion amount to benefit each grandchild and avoid gift tax if they pay for a grandchild's tuition or medical expenses. To take advantage of this exemption, the grandparents must pay the recipient directly (either electronically or via check).

Super Fund College Savings

Another way grandparents can assist with high school and college expenses is to contribute to a Qualified Tuition Program (aka 529 Plan) account for each grandchild. Grandparents can either contribute up to the annual exclusion amount each year or opt to "superfund" each account for up to five years.

The super funding strategy allows grandparents to make a lump sum contribution to a 529 plan account of up to five times the annual gift tax exclusion amount. However, the contribution must be treated as if spread over five years. That means an individual can contribute up to $90,000 to a 529 plan in 2024  ($180,000 if married, giving jointly) and not owe any gift taxes. However, you’ll have to file a gift tax return (IRS Form 709) for each of the five years to demonstrate that the contribution is being spread over five years. In addition, keep in mind that any additional cash or property gifts made to the same beneficiary during the five-year period will reduce the exclusion amount available for the 529 plan contributions. 

Direct Bequests

The simplest way to leave assets to grandchildren is to name them as beneficiaries in your will or trust. As the grantor or trustor, you can leave a set amount of money or a percentage of your assets to each grandchild as you determine. This option works well if all beneficiaries are physically and emotionally healthy, financially astute, and have reached adulthood. If any of the grandchildren are minors at the time of your death, however, their inheritance must be held in a custodial account or in trust until they reach the age of majority (either 18 or 21). Once the grandchild reaches the age of majority, they will obtain access to their inheritance. At that point, neither you nor the trustee or executor can control how the grandchild uses the money.

If any of the grandchildren are not physically or emotionally healthy, or lack financial discipline, you should designate a trust to hold their inheritance instead of having the assets go to them directly.

Grantor/Revocable Trust

A revocable grantor trust is the most flexible option for leaving an inheritance to minor grandchildren. This type of trust can be crafted to protect and manage your grandchildren's inheritance as you deem appropriate, even after your death. The trust document can include guidelines controlling how much of the trust assets may be used for the minor beneficiary's benefit, at what age the beneficiary may receive the trust assets outright, and under what conditions. Usually, the person creating a revocable trust (the grantor) is the trustee during their lifetime and can amend the trust terms as necessary. Upon the grantor's death, the person(s) named in the trust document serves as successor trustee(s) and ensures that the distribution and other terms of the trust are carried out as written.

Irrevocable Trust

Another option is to create an irrevocable trust for the benefit of your grandchildren. An irrevocable trust may allow you to make current gifts to the trust without incurring gift tax or using your lifetime gift tax exemption. In this way, you can reduce your taxable estate while still alive, potentially lowering the estate taxes owed upon your death.

Another type of irrevocable trust, a testamentary trust, comes into being upon death. The decedent's will includes the testamentary trust terms; there is no separate trust document. Commonly, the will states that a testamentary trust be created to hold the inheritance of any beneficiary who has not yet reached the age of majority at the time of the decedent's death.

Depending on the trust terms, irrevocable trust income may be taxed at trust tax rates rather than at much lower individual tax rates. Ensure you understand the tax ramifications of your trust plan before you sign off on it.

Health and Education Exclusion Trust

If your estate is large enough to trigger the generation-skipping transfer (GST) tax ($13.61M for individuals in 2024), you may reduce estate taxes by creating a health and education exclusion trust (HEET). A HEET holds assets used to pay for health and education expenses directly on behalf of the beneficiaries without subjecting the trustor to gift tax or the GST tax. To accomplish this result, the trustor must name a charitable institution as a beneficiary of the trust. While the trustee makes regular, reasonably substantial distributions to the charity, distributions to the human beneficiaries are exempt from the GST tax.

A HEET is useful in the following instances. If your goal is to subsidize education and medical expenses for your grandchildren, A HEET is a good option. Second, suppose you have used your full GST tax exemption through gifting or other estate planning strategies. In that case, the HEET enables you to make additional gifts without incurring GST tax. Third, a HEET lets you give to charity, potentially reducing both your current income taxes and future estate tax.

Consider Your Children’s Wishes

Though many grandparents seek to provide their grandchildren with an inheritance with good intentions, the parents may not appreciate their children receiving large sums of money outright. Be sure to speak with your children beforehand about how you can best support your grandchildren's development and provide for them in their early and later years.

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