Question: My only son and his wife are struggling financially due to his being laid off, the two of them using credit cards until they get back on their feet, and other effects of a downward spiral. Over the years, my wife and I have given our son nearly $30,000 to put away for the education of our two grandchildren, who are now 14 and 16. He recently admitted to me, however, that he had to use this money just to keep his family afloat, especially after his wife lost her job, too.

We feel that he has betrayed our trust by using the money earmarked for our grandchildren, but my wife and I don’t want to say anything given his desperate financial situation. Still, we don’t feel we can trust him now. (We had given the money directly to our son because we didn’t want to make gifts directly to our grandchildren that might be used for non-educational purposes, once they become of age. Also, we didn’t want to go to the expense of getting a lawyer to draw up a trust, and didn’t want the ongoing expenses of overseeing a trust.)

Now we are considering making gifts to a custodial account for each of our grandchildren because we believe our options are limited. Are we correct?

Answer: Since hiring a knowledgeable lawyer to prepare an appropriate trust would have been must less expensive than the $30,000 your grandchildren won’t get to use, we believe that your concerns are severely overstated and your options more expansive.

That said, let’s talk about the pro’s and con’s of making gifts under either the Uniform Gift to Minors Act (UGMA) or Uniform Transfer to Minors Act (UTMA), depending on the law of the state in which you live.

If you and your wife make gifts to accounts for your grandchildren under the terms of either of these laws, you will be making irrevocable transfers of your assets that you will not be able to get back. While these accounts are easy to open, each of your grandchildren will have complete and unfettered access and control of his/her account on the date he/she attains the age of majority -- between 18 and 21, depending on the law in your state of residence. And worse, there are no restrictions on the use of these funds, meaning that each could use his/her account for whatever strikes his/her fancy.
Still, in some instances, shifting income tax liability to children is a benefit of these types of accounts because the income is taxable to the minor.

However, because of the inflexibility of UGMA and UTMA accounts, the Internal Revenue Code was amended to include Section 529, which authorizes qualified state tuition programs or “College Savings Plans” that are specifically designated for educational purposes. Like UGMA/UTMA accounts and, for that matter, like outright gifts, you and your wife can each give $11,000 per grandchild ($22,000 annually to each, if you wish) without being required to file gift tax returns.

The qualified state tuition programs for chosen beneficiaries help offset the future cost of higher education and, for some, provide tax benefits. For example, in some state plans, contributions are deductible for state income purposes, and in all qualified plans, future distributions to designated beneficiaries are free of income tax if used for qualified higher-education expenses.

Some state plans will allow custodial accounts to be transferred into the Section 529 plan. Contributions must be in cash, not securities, and if your grandchildren don’t go to college, or you wish to take your money back for any reason, you will can get it back and pay taxes and a 10% penalty on earnings.

And then there are the trusts that you are trying to avoid. Too multifaceted for inclusion in this column, we believe that properly prepared trusts may be a viable option.

Taking the NextStep: Please do yourselves a favor and consult a knowledgeable attorney and/or financial planner who can tell you about all of your options. You have made a $30,000 mistake, and this is a lot of money. Don’t make another one.