More than half of the grandparents in the US are saving or plan to save for their grandchildren’s college expenses, according to a Fidelity Investments survey called “Generation Generosity.” If you’re one of them, how you decide to save and gift money for postsecondary education, including trade schools, should be determined by several factors. These include your grandchild’s eligibility for need-based financial aid…your personal estate plan…income tax breaks you can get in the state where you live…and how much control you’d like to retain over when and how the money is distributed.
Four popular options and how to decide which is best for you…
Write a check directly to the college. Advantages…
- You ensure that your money will be used for tuition.
- Because the IRS doesn’t consider the payment to be a gift, it doesn’t count against the $15,000 a year that you can give directly to a grandchild without triggering gift taxes. This may be useful for reducing the size of your taxable estate for estate-planning purposes. (Note: Payments for nontuition expenses such as books, travel and/or room and board do count toward the $15,000 annual gift-tax exclusion.)
Drawback: Colleges often treat payments that are made directly to the college as “cash support” on the student’s federal financial aid form, known as the Free Application for Federal Student Aid (FAFSA). Cash support is counted as untaxed student income, reducing aid by as much as 50 cents for every dollar
of income. Some colleges even treat direct tuition payment as a “resource,” which can have an even greater negative impact because every dollar contributed reduces the financial aid that the student qualifies for by a full dollar.
Best for: Grandparents whose grandchildren likely will not qualify for or need financial aid.
Open a 529 state-sponsored college-savings plan with your grandchild as the beneficiary. Advantages…
- You ensure that your money will be used for college expenses.
- The investments in the plan grow tax-free, and eventual distributions are tax-free when used for qualified educational purposes including many nontuition expenses.
- You can contribute as much as $15,000 a year ($30,000 if you are married) without triggering the gift tax. In a given year, you also are allowed to contribute up to five years’ worth of the annual gift-tax limit to the plan (as much as $75,000 or $150,000 if married). You won’t, however, be able to give your grandchild any more money for five years without gift-tax consequences.
- Money held in a grandparent’s 529 plan isn’t counted as a parental or student asset when determining a student’s aid eligibility.
- You receive a state income tax deduction or tax credit in 34 states
on contributions for using a 529 planoffered by the state in which you reside. (Arizona, Arkansas, Kansas, Minnesota, Missouri, Montana and Pennsylvania give you the break for contributing to any state’s plan).
Drawbacks…
- A 529 plan may have a very limited menu of investment options.
- Although assets in a grandparent- owned 529 plan are not counted in the financial aid formula, distributions are. They hurt your grandchild’s aid eligibility because they’re treated as his/her income, which is weighed more heavily than parental income and assets in the financial aid formula. You can work around this by delaying distributions until after the final tax year that counts toward the financial aid application for your grandchild’s college years is filed (typically after January 1 of the student’s sophomore year of college).
Best for: Grandparents who want to receive tax advantages on their contributions and maintain some control over the money if, for instance, the grandchild drops out of school, wins a scholarship or goes to a school that’s cheaper than expected.
Contribute to a 529 plan owned by the parents for the benefit of your grandchild. Advantages…
- Like most 529 plans, the investments grow tax-free, distributions are tax-free for qualified educational purposes and you still can contribute as much as $15,000 a year ($30,000 if you’re married) without worrying about gift taxes…or you can “super-fund” the plan with up to five years’ worth of contributions in a single year.
- Unlike grandparent- owned plans, distributions aren’t counted as income in the financial aid formula. The money is considered a parental asset, which has less impact on financial aid.
Drawbacks…
- A 529 plan may have a very limited menu of investment options.
- A parent controls the assets, not you, which creates a potential for family conflict. Example: The parent can change the beneficiary from your grandchild to any qualifying family member, which includes siblings, aunts, uncles, nieces, nephews, first cousins—even themselves. The parent also has the option of withdrawing the money for non-education purposes, which could mean paying income tax and a 10% penalty on the earnings portion of the distribution.
Best for: Grandparents who don’t want the responsibility of setting up and maintaining a 529 and who feel comfortable letting the parents make decisions.
Wait until after your grandchild graduates from college, and then help pay off his/her student loan. Advantages…
- You can write the check directly to the lender to make sure the money is used for paying down debt, up to $15,000 ($30,000 if married) annually without triggering gift taxes.
- The prospect of getting help with post-graduation debt can give your grandchild an added incentive to graduate.
Drawbacks…
- If you suffer unforeseen circumstances such as death or illness before your grandchild graduates, it may prevent you from being able to keep your promise.
Best for: Grandparents who are in good health and whose grandchildren are likely to finish school with a significant amount of student-loan debt.
Two options I would avoid…
- Setting up an education trust for the grandchild. In addition to the fact that setting up a trust can be costly, trust funds are considered to be part of the grandchild’s assets on FAFSA. That hurts aid eligibility because colleges typically expect that 20% of the assets owned by a dependent student will be used for educational expenses each year.
- Loaning money to your grandchild during college years, then forgiving the debt after the child graduates. Colleges consider such loans during college years to be “cash support,” which compromises your grandchild’s financial aid chances.
