College savings options for grandparents

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A grandparent’s college savings generosity knows no bounds, even in hard economic times.

A July poll by the MetLife Mature Market Institute in New York found that two-thirds of American grandparents provided financial support to their grandchildren during the past five years. The average amount given over that time period was $8,661, and 25 percent increased giving as the economic downturn unfolded.

The proliferation of attractive long-term investment opportunities — as well as a few counterintuitive giving strategies — has nudged aside the creaky old tradition of starting a grandchild’s college fund with a savings account and a fistful of U.S. savings bonds.

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Steven Foldes, a Miami-based Certified Financial Planner and recent first-time grandfather, says no right-thinking grandparent would tie a grandchild’s college tuition fund to savings bonds when inexpensive, higher-yielding portfolio options abound.

“If you do the math, the differential between the 4.5 (percent) to 5 percent long-term return of bonds and the 9 (percent) to 10 percent return of equities over a period of 18 years becomes huge,” he says.

Popular strategies

How are grandparents investing for the grandkids’ education these days? Here are a few popular college savings strategies:

  • Section 529 college savings plan. This 14-year-old educational investment vehicle, named after the Internal Revenue Code that created it, is administered at the state level, although a student may use the funds anywhere in the country.

    The popular plan enables investors to choose from a menu of mutual funds, much like an IRA or 401(k) plan. The parent retains full control of the fund, which is revocable. Anyone may contribute and there is no age restriction on a 529 plan.

  • Section 529 prepaid plan. Many states and public colleges and universities offer the option to prepay all or part of the cost of an in-state public college education. An Independent 529 Plan offers a similar program for private colleges.

    The return on investment will usually decrease should the recipient attend school out of state or choose a different college.

  • Coverdell education savings account. Think of Coverdell as an educational Roth IRA, although its annual limit of $2,000 per child and parental income limits make it an awkward fit for some families.

    The parent typically acts as custodian for this irrevocable fund; investment options may include mutual funds and/or individual stocks and bonds. On the plus side, the fund can be tapped for certain K-12 expenses. On the minus side, K-12 flexibility will expire — and contribution limits will drop to $500 annually — in 2010 unless Congress extends them.

    Coverdell contributions end when the recipient turns 18 and must be withdrawn by age 30 to avoid fees and penalties.

  • UGMA/UTMA. This supercharged, modern-day equivalent of a grandchild’s savings account was made possible by the Uniform Gifts to Minors Act, or UGMA, of 1956 and the Uniform Transfer to Minors Act, or UTMA, of 1986. It essentially allows donors to give or transfer assets into a custodial account for a minor without creating a trust.

Grandparents who don’t want to be restrained by the $13,000 annual gift tax exclusion or the limited investment options of 529 plans may prefer this approach. However, unlike 529s and Coverdells, an UGMA account is considered an asset of the child, which could affect their financial aid status.

Cash is king?

Of course, many grandparents simply prefer to give cash to the grandkids. The MetLife survey found that most of the grandparents polled (40 percent) helped with “general support” while 26 percent gave toward education.

“Seventy-eight percent thought it was more important to distribute smaller gifts throughout the year and throughout their lifetime rather than leave a large lump sum as a legacy,” says John Migliaccio, director of research for Mature Market Institute.

AARP family expert Amy Goyer, coordinator of the AARP Grandparent Information Center in Washington, D.C., attributes that trend in part to the struggling economy.

“I do think grandparents have cut back a bit on the kinds of investments they make,” she says. “They’re trying to be responsible about their own future.”

Financial planner and author Ric Edelman favors cash giving, with one twist.

“Write checks directly to the college or university to avoid the $13,000 annual gift cap,” he says.

That said, Edelman is convinced that most grandparents are aiming at the wrong target: Rather than invest in a college fund, they’ll have a greater impact by putting money toward the grandchild’s retirement.

Edelman estimates that a mere $5,000 minimum contribution into his Retirement InCome — for Everyone Trust, known as a RIC-E — or “Ricky” — Trust, could grow to $2 million or more by the time that newborn grandchild retires.

“That makes it much easier for the grandchild to refocus their saving on college, buying homes or even getting into careers that perhaps are not as lucrative,” Edelman says. “That could have a huge societal impact.”

While you won’t be around to bask in the moment, it’s a sure bet your heirs will never forget your generosity.

“Not only will your grandchild remember you, but so will their children and grandchildren because of the size of the legacy you are leaving them,” he says. “That is one way to provide a certain amount of immortality.”

Jay MacDonald is a contributing editor based in Clearwater, Fla.