Ask Tim: Is Grandma’s $30K a Tax Trap?

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This week, we’re looking at two planning questions that tend to show up as kids get older: how to pay for private school without disrupting the rest of the family’s plan, and how parents and grandparents can start moving money to the next generation without accidentally creating a tax problem.

Should we raid the 529 to keep three kids in private school?

Dear Tim,

We have three kids in private school, and tuition has gotten a little ridiculous. Our oldest has a healthy 529 balance, while the younger two are a few years behind.

We can afford tuition out of cash flow, but doing that means cutting back on retirement contributions and other investing for the next several years.

Would it make sense to start pulling from the oldest child’s 529 for private school now, then redirect some of the money we’re currently spending on tuition toward retirement and the younger kids’ 529s?

- Mr. 529 WorldWide

Dear Mr. 529 WorldWide,

This is a much better question than simply asking whether you can use a 529 for private school.

Beginning in 2026, federal rules allow families to withdraw up to $20,000 per beneficiary each year from a 529 for qualified K–12 expenses. The rules also expanded beyond tuition to include things like curriculum materials, books, tutoring, certain testing fees, dual-enrollment costs and some educational therapies.

So the mechanics may work. The planning question is whether moving money out of the oldest child’s account improves the family’s overall position.

The first thing I’d look at is your state. Federal treatment and state treatment are not always the same. Depending on where you live, a withdrawal that qualifies federally could still create state income tax or cause a previous state 529 deduction or credit to be recaptured. This is one of those situations where I’d want your advisor and CPA talking before the withdrawal happens, rather than figuring it out the following April.

Then I’d compare what you’re giving up on both sides.

If paying $60,000 or $80,000 a year in private school tuition means you stop maxing retirement accounts, postpone taxable investing and fall behind funding the younger children’s education, leaving every dollar untouched inside the oldest child’s 529 may not actually be the obvious choice.

You’re preserving tax-free college growth, but potentially sacrificing years of tax-advantaged retirement contributions elsewhere.

On the other hand, I wouldn’t automatically start draining the oldest child’s account simply because tuition is painful today. If that child is only eight or nine, those dollars could still have a decade or more to compound before college. You also don’t want to solve today’s tuition problem by creating a much larger college funding gap later.

This is where I’d model a few scenarios.

What happens if you continue paying tuition entirely from cash flow? What happens if you use $10,000 or $20,000 per year from the 529 and redirect the freed-up cash toward retirement? And what happens if you use the 529 only during especially expensive years, such as when multiple children are in private school at the same time?

I’d also look outside the 529 before deciding. Private schools may have their own financial-aid programs, scholarships or payment options. Beginning in 2027, there will also be a new federal tax credit of up to $1,700 for qualifying contributions to Scholarship Granting Organizations in participating states. Those organizations can then provide scholarships for K–12 education, although availability will depend on the state and the individual organization.

Ultimately, I’d make this a household balance-sheet decision.

If the 529 is significantly overfunded while retirement savings are being squeezed, using some of it earlier could actually make the overall plan healthier. If college is still substantially underfunded, I’d be much more reluctant.

The 529 is another tool in the toolbox. The question is whether using it now improves the overall plan or simply moves a future expense into the present.

Grandma wants to give our 16-year-old $30,000. Where should it go?

Dear Tim,

Our 16-year-old already has about $80,000 in a UTMA that my parents have been funding for years.

Now my mother wants to give him another $30,000 this year.

At the same time, he just started working at our family business on weekends and will probably earn around $8,000. He wants to use some of his money for a car next year, and we’d like to start a Roth IRA for him.

Do we keep putting Grandma’s gifts into the UTMA, or is there a smarter way to handle this now that he has his own income?

- Where’s My Money, Grandma

Dear Where’s My Money, Grandma

This is exactly the point where I’d stop treating every gift the same way.

The UTMA may have worked perfectly when your son was five. At 16, with $80,000 already sitting there, employment income starting to come in and college, a car and adulthood all approaching, I’d want to think much more carefully about where the next dollar goes.

Remember, money in the UTMA legally belongs to your child. Depending on your state, he will eventually gain control of that account. If Grandma puts another $30,000 into it, she isn’t simply helping with college or buying him a car someday. She is permanently transferring another $30,000 into an account that will ultimately be his to control.

There’s also the tax side.

Interest, dividends and capital gains inside the UTMA are generally the child’s income. For 2026, certain children with more than $2,700 of unearned income can become subject to the kiddie-tax rules, which can cause some of that investment income to be taxed using the parents’ tax rate.

So before adding another $30,000, I’d want the CPA to look at what the existing UTMA is already generating each year. An $80,000 account invested heavily in growth stocks may produce very little taxable income until something is sold. An account holding dividend-paying investments or realizing gains regularly could create a very different tax picture.

Then I’d separate Grandma’s gift from your son’s wages.

His $8,000 of legitimate employment income creates an entirely different opportunity. Because he has earned income, he may be able to contribute to a Roth IRA, up to his taxable compensation for the year and subject to the annual IRA limit.

And he doesn’t necessarily have to use his actual paycheck to make the contribution.

For example, your son could earn $8,000 working, use some of those paychecks toward his car, and a parent or grandparent could give him money to help fund the Roth or simply fund a Custodial Roth on his behalf. What matters for the contribution limit is that he had enough qualifying earned income.

That may be one of the more valuable gifts Grandma can make. Instead of adding another $8,000 to an already substantial UTMA, she could effectively help him move some money into an account with decades of potential tax-free growth.

For the rest of Grandma’s gift, I’d ask what she actually wants the money to accomplish.

If the goal is college, a 529 may provide more control and potentially better tax treatment than adding more to the UTMA.

If she specifically wants to buy him a car, she may simply help with that expense when the time comes.

If she wants to transfer wealth to him with no restrictions, the UTMA may still be appropriate. But I’d make that decision consciously rather than continuing to fund it out of habit.

Grandparents also have the ability to pay qualifying tuition directly to a school, and when structured properly, those direct tuition payments are excluded from federal gift tax and do not use the donor’s normal annual gift-tax exclusion.

For 2026, an individual can generally give up to $19,000 per recipient under the annual federal gift-tax exclusion, or $38,000 if a married couple each makes qualifying gifts. Larger gifts may still be possible, but that is where gift-tax reporting and the family’s broader estate plan start to matter.

This is why I like looking at family gifting as a coordinated strategy rather than a series of checks.

Your son now has several different buckets available to him, and they each do something different. The UTMA offers flexibility but eventually gives him control. The 529 is more targeted toward education. Earned income opens the Roth IRA door. Direct payments can sometimes accomplish Grandma’s goal without adding another investment account at all.

At this stage, I’d want the advisor and CPA looking at all of them together.

The goal isn’t simply to give him more money. It’s to decide what Grandma wants that money to do first, then put it in the account best suited to do it.