What's the Best Way to Set up an Education Fund for My Grandchild?
Dear Carrie: I'd like to set up an educational fund for my new grandchild. I understand the tax benefits of a 529 account but am also interested in gifting appreciated stock. What are your thoughts? -- A Reader
Dear Reader: Congratulations on your new grandchild! I also applaud your generosity. What a fortunate child to have such a supportive family.
You're also wise to weigh your options. A gift of appreciated stock can be a great way to fund education. On the other hand, as you mention, a 529 account has several advantages, but it only accepts cash, not stock or other assets.
As is so often the case, the devil is in the details. Regardless of whether it's you or your grandchild who ultimately sells the appreciated stock, that person may be hit with a tax bill that can include federal capital gains tax and, potentially, net investment income tax and state taxes.
New rules under the Tax Cuts and Jobs Act of 2017 mean that gifting appreciated stock to a minor is far less attractive than in the past. In a nutshell, assets owned or sold under a child or grandchild's name can be hit with tax rates faster and higher than assets sold by a parent or grandparent.
As a Grandparent, You Have a Few Ways to Gift the Stock
1. You can gift the stock in kind and have it sold under the grandchild's name. This used to be a common strategy under old tax rules. As we'll discuss below, it's not as effective as it used to be.
2. You can sell the stock and gift the after-tax proceeds to your grandchild. This can make sense if you would pay lower taxes on the sale than your grandchild would. New tax rules can result in a child or grandchild's tax liability being higher than that of a grandparent.
3. You can make a gift of the stock to your grandchild at your death. This takes advantage of a step up in basis, which means paying no taxes on any appreciation on the stock. In this way, you can make a larger gift, but the downside is you won't be around to see it.
A big part of your decision, therefore, will be based on the difference in the total tax burden for you versus your grandchild in selling the stock. In addition, you'll want to weigh the pros and cons of placing college funds in a custodial account versus a 529. Let's take a closer look.