Ways for Grandparents to Help Fund College
Grandparents with means have long faced an impediment in efforts to help pay for their grandkids’ college education. Now the restraint on grandparent generosity is in the process of being removed.
Financial aid rules that penalized the student’s eligibility for federal money when grandparents contributed to their 529 college savings plans have been revised to scrap that restriction starting with the 2024-25 school year (pushed back a year from the original target date due to needed technology upgrades). Grandparents will be able to contribute substantial amounts to the students from their 529 accounts without jeopardizing other aid.
While state-run 529 plans are hardly the only way to pitch in toward tuition costs, their appealing tax benefits make them a popular approach. Withdrawals spent on qualified higher education expenses avoid federal income and capital gains tax, and some states offer additional state tax benefits.
That makes the impending change not only a feel-good one for grandparents but one that can enhance their own financial situation.
The gift of education to a grandchild is mutually beneficial, lowering your taxable estate and rewarding your loved one with education that doesn’t come with student loan debt later on in life, says Donald J. Sorota, CFP®, CPA, a founding partner and managing director of Altair Advisers.
The change is part of a much-needed revamp of the FAFSA, or Free Application for Federal Student Aid, that students and their families fill out when applying for financial assistance – a form long dreaded for its length and complexity. Under the old FAFSA rules, students were required to report distributions from grandparent-owned 529 plans as untaxed student income, which had the potential to reduce a student’s aid eligibility by up to 50% of the distributed amount from the college saving plan. Among many other revisions, the simplified FAFSA will remove the question about outside contributions, freeing up not just grandparents but all other non-parent family members to contribute as much as they wish into their own 529 accounts without repercussions when the student withdraws the funds later.
A 529 plan is just one of the ways that grandparents can pitch in at tuition time. We take a look at the pros and cons of each:
Outright Gift to Grandchild or Their Parents
While generous and perhaps more personal than other methods, giving large amounts of cash or stock to your young grandson or granddaughter for their future college is an option you should approach with caution.
The positives include being able to give each grandchild up to $16,000 a year ($32,000 for joint gifts) without having to report them. These gifts can also help reduce the size of your estate, another tax plus. But putting substantial assets in the direct control of a minor – best intentions notwithstanding – carries obvious risks.
There also are drawbacks even if college is imminent. Exceeding the annual $16,000/$32,000 exclusion amount could cost you in not only gift tax but the generation-skipping transfer tax (GSTT). This tax addresses the shift of property by gift or at death to a person two or more generations below that of the gift-giver. A direct gift of cash or stock to a student also could subject them to the “kiddie tax” if that gift subsequently produces income – causing them to be taxed at their guardian’s higher rate on unearned income above $2,300.
A better approach: Give the cash to the parents (subject to the same $16,000/$32,000 annual exclusion amount), since the gift will not then have to be reported when applying for student aid.
Direct Tuition Payment
Writing tuition checks to your grandchild’s school is certainly an effective way of accomplishing your goal if you are interested in covering part or all of the bill. Just be sure to consider all implications.
Because tuition payments made directly to the college are not considered taxable gifts, there is no need to file a gift tax return. (The gift-tax exclusion does not apply to room and board, activity fees, book fees and similar expenses.) This is a surefire way to guarantee that your money is used solely for educational purposes. If you choose to pay for more than tuition, you also can give your grandchild a separate tax-free gift of up to the $16,000 (or $32,000) annual limit.
The potential downside is that your gift likely will negatively impact your grandchild’s eligibility for financial aid, assuming he or she would qualify. If you are making this gift before 2024, check with the parents and/or a counselor or college aid expert to learn how it might reduce aid available through the student’s FAFSA application. While that becomes less of a concern beginning in 2024, you should still check with the college to see what impact a payment would have on any institutional aid they might provide.
529 Plan
Enrolling in or contributing to a 529 college savings plan is one of the smartest financial moves you can make on behalf of a grandchild, with tax benefits for you as well. As mentioned above, these plans offer significant federal income tax breaks, sometimes state tax benefits as well and a low-maintenance, largely self-controlled way to save for college. You simply need to think ahead, ideally way ahead, to maximize the benefit of this strategy.
Grandparents can establish 529s and name the grandchildren as beneficiaries. Unlike Coverdell education savings accounts, which have contribution limits of $2,000 a year, 529s have high contribution limits – ranging from around $235,000 on the low end to more than $550,000 per beneficiary, depending on the state. You can make a single lump-sum gift of as much as $80,000 ($160,000 for married couples) without suffering tax-wise, as special rules for 529s allow you to front-load them by contributing up to five years’ worth of annual $16,000 gifts at once without incurring a gift tax.
Until the financial aid rule change takes effect in the 2024-25 school year, the amount withdrawn from these plans for college will be counted as student income on the FAFSA. But money in the account has no effect on the student’s financial aid eligibility.
If your grandchild does not attend college, you can avoid a tax penalty by changing the beneficiary. The IRS allows one tax-free rollover every 12 months to another 529 plan (although contributions to 529 plans could be subject to the GSTT if the new beneficiary is a family member in a different generation). Otherwise, you will face penalties on withdrawals if the money is not used for qualified education expenses. Qualified education expenses now include vocational and trade school, or even public or private elementary and secondary school.
Custodial Account
Setting aside money for a child or grandchild in a UGMA (Uniform Gifts to Minors Act) or UTMA (Uniform Transfers to Minors Act) account has been popular since long before 529s. They are simple to set up, the grandchild’s first $1,150 of unearned income is sheltered from taxes and there is no limit on contributions or restriction on what the funds can be used for.
The giant downside is that the child gains full control at adulthood – age 18 or 21, depending on the state. Thus there is no assurance that the money will be spent on college. If there are significant assets in this account, too, the kiddie tax can become a big issue.
Irrevocable Trust
Creating an educational trust allows you to specify your wishes for your grandchild, with the trustee legally obligated to adhere to them. Designating it as a lifetime asset protection trust enables you to spell out the terms for distribution on a schedule of your choosing. In other words, it won’t get blown on a trip to Bali or a new sports car. The trust can also be funded in part by other family members.
Legal and accounting fees to set up and maintain a trust can be high, and income earned in the trust is taxed at high rates. Irrevocable also means that, unlike with other options, you cannot get your gift(s) back without the consent of the trustee and beneficiaries. But if control and conditions are important to you, this option provides strong influence over the desired outcome.
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These are not the only strategies. You could also give your grandchild an interest-free loan of up to $10,000, pay off their student loans after they graduate, give them education savings bonds (in their parents’ name for tax purposes) or give them the gift of professional financial planning to help them assess their own college and post-college finances. For doting grandparents, there are many ways to help your grandchildren navigate the maze of college finances.
For more details on your options, consult your financial adviser.
The material shown is for informational purposes only and should not be construed as accounting, legal, or tax advice. Altair Advisers LLC is a registered investment adviser with the Securities and Exchange Commission; registration does not imply a certain level of skill or training. While efforts are made to ensure information contained herein is accurate, Altair Advisers cannot guarantee the accuracy of all such information presented.