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How can grandparents invest for their grandchildren?

This article provides multiple options for grandparents to transfer family wealth to their grandchildren.

How can grandparents invest for their grandchildren?


Posted on 07 Jul 2024
Author: Sayan Sircar
14 mins read
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This article provides multiple options for grandparents to transfer family wealth to their grandchildren.

How can grandparents invest for their grandchildren?

This article is a part of our detailed article series on the concept of building and transferring generational wealth. Ensure you have read the other parts here:

📚 Topics covered:

Why should grandparents invest for their grandchildren?

There are multiple reasons, apart from love and affection, that justify investing for grandchildren:

  • Compartmentalizing assets to optimize asset allocation and taxation
  • Ensuring that wealth is transferred to the generation that needs it at the right time

Warning: Investment for family members should be made only when you have enough in your retirement portfolio to last your and your spouse’s expected lifetime.

We will now break these down and explain them in more detail.

What is meant by asset compartmentalization?

Asset compartmentalization here refers to carving out a portion of their assets to be spent on a future date for a particular purpose. The benefit of this type of physical separation is that the investment can be then invested in high-risk investments, like equity mutual funds, and allowed to grow.

Bucket-wise Asset Allocation in Retirement

This slice of the portfolio, earmarked for the grandchildren, is now separate from the one used for day-to-day expenses which is likely to be more conservative as the chart above shows.

Related:
Do the worst performing equity mutual funds beat FD?

What is meant by generational wealth transfer?

Generational wealth is how financial assets get transferred from one generation to the next. The alternative to creating generational wealth is that each generation starts its investment journey from scratch since the previous generation depleted all the corpus.

We have covered this concept before here: Building Generational Wealth through an Alternative Retirement Portfolio Planning Technique

By starting a separate investment for the grandchildren, by investing in inflation-beating assets, the grandparents are ensuring that their wealth gets transferred to the newest generation and gets used at the right time.

What is meant by using the investments at the right time?

Grandchildren will be able to spend this corpus when:

  • they enter college (either UG/PG/PhD)
  • they enter the job market and need setup costs in a new city
  • they wish to purchase a house
  • they get married
  • they wish to start a business

Whatever the purpose, the grandparents here will have complete control over what the investment is to be used for and when.

What investment options are available for grandparents to invest for their grandchildren?

Our main aim of investing is generally to grow the corpus at a suitable pace covering long-term inflation associated with the particular goal. For example, college education fees generally grow at 7-10% in India. If the college is abroad, the inflation in fees might be lower, but there is the impact of Rupee depreciation as well.

Asset Inflation Ticker size Regulations Liquidity Income Taxation
Mutual funds High Low High High SWP Best
Shares High Low High High Dividend Best
Real estate Low Highest None Lowest Rent Medium
Gold Medium Low Medium High None Low
FD Low Low High High Interest Worst
Bonds Low Medium Medium Low Coupon Worst

Overall, equity mutual funds, are a good investment option due to professional management, liquidity (you can take out the amount at any time) and inflation-beating characteristics. If you are uncomfortable with this asset class, consider taking professional guidance.

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What about investing in income-generating investments?

A case can be made about income-producing investments if the purpose is to pay college fees every semester or something equivalent. In such a case a government bond or SGB with regular 6-monthly coupon payment can be an option. The maturity value of that investment can be used for a lump sum goal like marriage or house purchase.

You can use this formula to calculate income from bond price and coupon rate:

Monthly income = 100 * Coupon * Investment / Price / 12 * (1 - TaxRate)

For example, if you buy a 2030, 7.28% coupon bond at a price of ₹105 by investing ₹50 lakhs then you get:

  • notional value of the bond purchased = 100 * 50/105 = ₹47.62 lakhs
  • interest payment every six months = 0.5 * 7.28% * ₹47.62 lakhs = ₹1.73 lakhs pre-tax (this is sufficient for an IIT degree at today’s rates)
  • tax can be saved by investing in the grandchild’s name by gifting ₹50 lakhs (no tax) and then investing via RBI Retail Direct. If the grandchild has minimum or no income, the interest will be tax-free

You can also get similar results from a portfolio of dividend-paying stocks: Understanding dividend investing: should you invest in stocks or mutual funds for dividend income?

How should grandparents invest a lump sum for their grandchildren?

There are two aspects here if you are thinking of investing a large amount in one go:

  • what is the impact on your own retirement portfolio by taking out this chunk
  • will the corpus grow better as a lump sum vs. regularly (SIP) depending on the time left and the purpose of the investment

If you are confident that you can spare the amount by making a large one-time investment, then a lump sum investment makes the most sense.

Related:
How to invest a lump sum amount when the stock market is at an all-time high?

How should grandparents invest regularly for their grandchildren?

An alternative case can be made if there is spare regular income (interest, rent, pension, dividend) etc. in the grandparent’s family that can be used to invest for the grandchild. A common investment option is regular investment in mutual funds (equity for the long term, hybrid for the medium term and debt for the short term).

A recurring deposit can be considered if the goal of the investment is due in the next few years.

You can even set up a gold-accumulation scheme via physical gold or SGB: What is the best way to accumulate gold for your child’s wedding?

Another popular option is investing in the Public Provident Fund (PPF) for both boys and girls and Sukanya Samridhhi Yojana (SSY) for only girls

To understand what is the best thing to do in these circumstances:

How should mutual funds be managed if grandparents invest for their grandchildren?

A demat-based mutual fund investment account is the best way of investing in mutual funds for grandchildren. We will explain how.

  • Step 0: Complete mutual fund KYC. This can be done online: How to update your KYC to continue investing in mutual funds from 1st April 2024?
  • Step 1: Open an account with a demat-based mutual fund investment platform. There are several in India.
  • Step 2: Invest a lump-sum amount (if at all) and/or start a SIP in a suitable mutual fund
  • Step 3: Make your child (the grand-kid’s parent) the nominee of this account. The account should be opened in single mode (not joint)

Continue investing in this account as per your wish and cash availability.

Before selling you have two options:

  • sell the units in your own name, pay capital gains tax and use the amount: How to calculate and save tax on mutual funds?
  • since the units are held in a demat account, you can transfer the units as a gift to the parent (if the child is a minor and the parent is in a lower tax bracket than you) or the grandchild (if major) without any tax on you

Related reading:

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How should grandparents invest if their grandchild is an NRI?

Investing for a grandchild where the amount will be used abroad has complexities around tax laws both abroad (e.g 529 plans in the US) as well as in India (LRS regulation for example - How the government has provided relief to travellers and international investors by tweaking the LRS and TCS rules from 1st Oct 2023?).

Also, there are additional complexities around holding PPF and SSY accounts for NRI children: How should NRIs handle investments and accounts in India before shifting?

In such cases, it is simplest to keep the investment in India in the name of the grandparent and explore the options when the money is to be used.

Should grandparents invest in their own name for their grandchildren?

We are a big supporter of retaining control over investments until the point of usage. This stance takes care of issues if the recipient of the gifted corpus is either unable to manage the sum themselves or ends up spending it for any other purpose.

Investing this way allows you the flexibility to distribute the amount over time (e.g. college semester fees) or at one time (say house downpayment) while retaining control for using the amount only for the intended purpose.

Why should grandparents not invest in the name of the parents of their grandchildren?

An example will make this point clear.

You, as the grandparent, had accumulated 10 lakhs in the name of your son who is the father of your grandchild for college admission. When the child is 15, the family decides to spend that money on a trip to Disneyland.

Therefore all investments should be maintained in the name of the grandparent, either singly or jointly, with their child, i.e. the parent of the grandchild as the nominee. Nomination, ideally enforced via a will, ensures that once both grandparents are no more, the amount passes on to the parent of the grandchild.

There is no benefit to making the minor grandchild the nominee since their parents are anyway the legal guardian. If the grandchild is a major, they can be made the nominee directly.

What should be done when the grandchild becomes an adult?

There are two options at this point besides continuing the investment as is:

  • any investment held in a Demat account (shares, mutual funds, SGB, bonds etc.) can be gifted to the grandchild without tax. Taxes will be saved, since the grandchild at that time will have limited income, when these investments are sold
  • assets that can have ownership transfer like cash, real estate, jewellery etc can be directly gifted without any gift tax

In every case, it is best from an income tax standpoint, to make a gift deed to record the gift.

Should grandparents mention this investment in their will for their grandchildren?

Nominees are not legal heirs. To ensure that the investment passes to the correct recipient, a will must be created and this investment mentioned explicitly.

Related:
Frequently asked questions (FAQs) on legal heirs and nominees in India

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This post titled How can grandparents invest for their grandchildren? first appeared on 07 Jul 2024 at https://arthgyaan.com


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