By: Thomas D. Begley, Jr., Esquire, CELA
CASE STUDY
GRANDPARENTS USE BOTH ESTATE PLANNING AND LIFETIME GIFTS TO ASSIST GRANDCHILDREN
Harry and Sally have two grown children and four grandchildren who are all under age 18. Harry and Sally are close to their children, Bill and Irene. The grandchildren are a source of joy and pride and occupy a special place in their hearts.
Harry and Sally want to include their grandchildren in their estate plans. They originally planned to simply leave everything to Bill and Irene and let them take care of the grandchildren. Then, a friend told them about his grandmother’s will, which included specific bequests to each of the grandchildren. That arrangement made all of the grandchildren very happy, not so much because of the money involved, but because the grandmother had remembered each one of them in her will.
Another friend, a lawyer, advised Harry and Sally that some grandparents set aside separate shares of their estate to be divided equally among grandchildren. For example, Harry and Sally might divide their estate into thirds, leaving one-third to each of their two children and the remaining third to be divided equally among the four grandchildren. Since the grandchildren are minors, their share of the estate might be placed into a “grandchildren’s trust.” Funds in this trust could be used for each grandchild’s education or to assist each of them in buying a home or starting a business.
At a certain age, perhaps 30, the grandchildren could be entitled to withdraw the money and use it as they pleased.
Testamentary Trusts
Harry and Sally liked the attorney’s idea.
They decided to adjust their wills accordingly and to establish a testamentary trust for the grandchildren, which would go into effect after both of them had passed on. Harry and Sally also wanted to take steps during their lifetime to help fund the college education of each grandchild.
Since 529 plans had been established for all four grandchildren, Harry and Sally decided to begin making annual gifts to those accounts.
What Concerns Might Grandparents Have Pertaining To Their Grandchildren?
The relationship between a grandparent and a grandchild is a special one. Whether it is due to the difference in age or the fact that grandparents already have raised their own children, grandparents tend to view their grandchildren from a unique perspective. Grandparents often have concerns about the following:
Pocket Money. Equitable distribution is a division of the marital assets. If one of the divorcing spouses is disabled, the existence of the equitable distribution will prevent that person from accessing public benefits and will cause a loss of any existing public benefits. The solution is to have the equitable distribution paid into an SSSNT for the benefit of the disabled spouse.
College. They want their grandchildren to receive a college education without incurring enormous student loan debt.
Business. They want each grandchild to be able to start a business, if appropriate.
Automobiles. They want each grandchild to be able to own a car.
Home Ownership. They want each grandchild to be able to buy a home.
Problem Grandchildren. Grandparents often want to assist grandchildren, even when they have problems such as drug/alcohol addiction or a history of criminal behavior.
Grandchildren Who Need Incentives. Grandparents are often interested in helping to motivate grandchildren who otherwise lack drive and self-discipline.
What Tools Are Available To Address These Concerns?
The topic of charitable giving, or planned giving, sparks many questions about the income tax ramifications of such generosity. While the tax benefits of planned giving vary, depending on the technique utilized, one commonality is that gifts result in charitable income tax deductions. These deductions are not on a dollar-for-dollar basis, however, be such a tax benefit would have the result of making charitable giving too appealing, potentially depleting the nation’s tax coffers.
Gifting
A grandparent can gift each of his or her grandchildren up to $15,000 a year by taking advantage of the annual exclusion gifts under the federal gift tax law. Gifts for college expenses are exempt, regardless of amount, as long as payments are made directly to the educational institution. Gifts for medical care are also exempt as long as payment is made directly to the provider.
Specific Bequests in a Will or Trust
A will or trust can provide that each grandchild will receive a fixed amount. That amount may be $1,000 or $50,000, depending on the size of the grandparent’s estate and the number of grandchildren. Also, each grandparent can leave a bequest at his or her death, or the bequest can be deferred until the death of the surviving grandparent.
Incentives
Wills and trusts can be used to provide for grandchildren with problems, such as addictive illness or criminal behavior. They also can be used to help motivate grandchildren who otherwise lack direction. For example, the will or trust may precondition receipt of funds on such events as graduating from college or retaining a job that pays a certain basic annual salary.
Percentage Share of Estate
A grandparent’s will or trust can provide that the grandchildren receive a percentage share of the total estate. Typically, the transfer of funds to each grandchild occurs upon the death of the surviving grandparent. If a grandchild is old enough, monies can be left to him or her outright. If he or she is a minor, the monies can be held in trust. A trustee is authorized to use the money for the grandchild’s health, education, maintenance, or support, or to assist the grandchild in purchasing a home or starting a business. The trustee may be the grandchild’s parents. A variation on this strategy is to establish one trust with funds to be divided equally among all grandchildren.
529 Plans
These plans offer an excellent way to save for college education expenses. A grandparent may establish a 529 Plan for the benefit of a grandchild or contribute to one already established.
Coverdell Education Savings Accounts (ESAs)
A grandparent can establish or contribute to an ESA.
2503(c) Trusts
A 2503(c) trust can be established by a grandparent for the benefit of a grandchild under age 21.
What Should Grandparents Know About College Savings Alternatives?
The 529 Plan. Created under Section 529 of the Internal Revenue Code, 529 plans are designed to help families save for their children’s college education. Anyone, including grandparents, may establish these plans and/or make annual, nondeductible contributions to them. Qualified state tuition plans are maintained by each state or state agency. A resident of one state may open a 529 plan in another state. Funds may be withdrawn for qualified higher education expenses at any qualifying college, university, or graduate school, and at most community colleges and vocational/technical schools. Educational expenses for private primary schools and high schools do not qualify.
Important considerations regarding 529 Plans include:
Estate Tax. Funds in 529 plans generally are not includable in the estate of either the contributor or the beneficiary.
Income Tax. The principal tax advantage of a 529 Plan is that the investment income earned in the account escapes federal income taxation and, in many states, state income taxation, provided that the funds are used exclusively for qualified higher education expenses. The longer the 529 Plan is in effect, the more tax free income is accumulated. Funds not used for college education expenses are taxed as ordinary income to the distributee, with a 10% penalty imposed on the amount withdrawn.
Contribution Limits. The lifetime amount that can be contributed to a 529 plan varies by state.
Cash. Investments must be made in cash.
Annual Exclusion Gifts. Gifts to a 529 Plan qualify as annual exclusion gifts. In fact, it is possible to “bunch” five years of gifts into one year, as long as no contributions are made in the succeeding four years. Consequently, gifting funds to a 529 Plan is a very effective way to remove large sums of money from the contributor’s estate. The ability to frontload the plan can maximize tax free income to the beneficiary.
Qualified Higher Education Expenses. 529 plan funds can be used for tuition, fees, books, supplies, and equipment, as well as for room and board when the beneficiary attends school at least half time.
Change in Beneficiaries. Beneficiaries can be changed at any time as long as the new beneficiary is a member of the family. If a particular grandchild decides not to attend college, or if funds remain in the account after the grandchild graduates from college, another grandchild can be designated as beneficiary.
Financial Aid. Funds in a 529 plan are not counted for purposes of calculating financial aid eligibility.
Advantages and Disadvantages of 529 Plans
| Advantages | Disadvantages |
| Donor controls account (i.e., donor can change beneficiaries and withdraw contributions). | Funds not used for qualified education expenses are subject to tax and penalty on the earnings portion. |
| Allows for myriad investment options. | Stock investments are volatile and may go up or down. |
| Grandparents may establish or contribute to fund. |
Important considerations regarding an ESA include:
Qualified Education Expenses. Funds in an ESA can be used for elementary and secondary school (grades K through 12) expenses, including tuition, fees, tutoring, books, supplies, and equipment.
ESA Funds. ESA funds can also be used for qualified higher education expenses, including tuition, fees, books, supplies, and equipment, at eligible educational institutions. Room and board is considered a qualified expense provided that the recipient attends school at least half time.
Rollover. The responsible individual (account owner) can change the beneficiary at any time to another qualifying “family member” who is under age 30. The term “family member” is broadly interpreted.
Transfer From an ESA to a 529 Plan. Funds in an ESA can be transferred to a 529 Plan.
Age Limitation. Funds must be withdrawn fully by the time the beneficiary reaches age 30, or the remaining account will be paid out within 30 days, subject to tax on the earnings and an additional 10% penalty. The penalty does not apply to withdrawals made due to the beneficiary’s death or disability, or to the extent the beneficiary receives a tax free scholarship.
Gift Tax. The contribution to an ESA is treated as a gift under the annual gift tax exclusion.
A Comparison of ESA and 529 Plans
| ESA | 529 Plan | |
| Annual Contribution Limit | $3,000 | $15,000 ($75,000, if 5-year annual exclusion gifts are aggregated) |
| Purpose | Elementary, secondary, and college | Higher education only |
| Date for Contributions | April 15 of the following calendar year | December 31 of calendar year |
| Income Level Requirement | Yes | No |
Gifts to a 2503(c) trusts
A gift to a 2503(c) trust will be treated as a present interest as long as the beneficiary of the trust is under age 21 and the following requirements are satisfied:
ONE: The trustee has the power to use the gifted property and income for the benefit of the minor before the minor reaches the age of 21.
TWO: The minor has the right to withdraw income and principal at age 21.
THREE: If the minor dies prior to age 21, the income and principal is paid to the minor’s estate or to persons the minor selects by exercising a general power of appointment.
2503(c) TRUSTS
A 2503(c) trust is a trust established to hold funds for a child until he or she turns 21. When contributing to a 2503(c) trust, the gift tax annual exclusion can be utilized. The key to a 2503(c) trust is that there are no substantial restrictions on the exercise of the trustee’s discretion to make distributions. Limiting the trustee’s discretion to making distributions for education expenses would be considered a “substantial restriction.”
Uniform Gifts to Minors Act (UGMA)
Gifts under the Uniform Gifts to Minors Act (UGMA) also qualify for the gift tax annual exclusion. These gifts are irrevocable because a custodian must be selected, and a successor may be designated. The major drawback of such a gift is that the assets in the custodial account must be paid over to the minor, either at majority or age 21, depending on state law. If the donor is also the custodian, the assets in the custodial account are included in the donor’s estate.
WHAT ABOUT BENEFICIARY DESIGNATIONS?
It is critical to coordinate beneficiary designations for life insurance policies, retirement plans, and annuities
This is to ensure that funds go to the intended beneficiaries. Failure to do this can undermine estate planning strategies. For example, let’s say that a grandfather decides to leave each of his two children one-third of his estate, and the remaining one-third left in trust for four grandchildren that is to be divided equally among them. In order to ensure that this plan will be carried out, the grandfather would need to name both his children and the grandchildren’s trust as beneficiaries of his life insurance policies, IRAs, and annuities. If only his children were named as beneficiaries, the funds from those policies and accounts would not be available to the grandchildren’s trust.