As the cost of a col­lege edu­ca­tion con­tin­ues to climb, many grand­par­ents are step­ping in to help.  This trend is expect­ed to accel­er­ate as baby boomers, many of whom went to col­lege, become grand­par­ents and start gift­ing what’s pre­dict­ed to be tril­lions of dol­lars over the com­ing decades. 

Help­ing to pay for a grandchild’s col­lege edu­ca­tion can bring great per­son­al sat­is­fac­tion and is a smart way for grand­par­ents to pass on wealth with­out hav­ing to pay gift and estate tax­es.  So what are some ways to accom­plish this goal?

 

Outright Cash Gifts

A com­mon way for grand­par­ents to help grand­chil­dren with col­lege costs is to make an out­right gift of cash or secu­ri­ties.  But this method has a cou­ple of draw­backs.  A gift of more than the annu­al fed­er­al gift tax exclu­sion amount–$14,000 for indi­vid­ual gifts and $28,000 for gifts made by a mar­ried couple—might have gift tax and gen­er­a­tion-skip­ping trans­fer (GST) tax con­se­quences (GST tax is an addi­tion­al gift tax imposed on gifts made to some­one who is more than one gen­er­a­tion below you).  Anoth­er draw­back is that a cash gift to a stu­dent will be con­sid­ered untaxed income by the fed­er­al government’s aid appli­ca­tion, the FAFSA, and stu­dent income is assessed at a rate of 50%, which can impact finan­cial aid eli­gi­bil­i­ty.  

One workaround is for the grand­par­ent to give the cash gift to the par­ent instead of the grand­child, because gifts to par­ents do not need to be report­ed as income on the FAFSA.  Anoth­er solu­tion is to wait until your grand­child grad­u­ates col­lege and then give a cash gift that can be used to pay off school loans.  Yet anoth­er option is to pay the col­lege direct­ly.  

 

Pay Tuition Directly to the College

Under fed­er­al law, tuition pay­ments made direct­ly to a col­lege aren’t con­sid­ered tax­able gifts, no mat­ter how large the pay­ment.  So grand­par­ents don’t have to wor­ry about the $14,000 annu­al fed­er­al gift tax exclu­sion.  But pay­ments can only be made for tuition—room and board, books, fees, equip­ment, and oth­er sim­i­lar expens­es do not qual­i­fy.  Aside from the obvi­ous tax advan­tage, pay­ing tuition direct­ly to the col­lege ensures that your mon­ey will be used for the edu­ca­tion pur­pose you intend­ed, plus it removes the mon­ey from your estate.  And you are still free to give your grand­child a sep­a­rate tax-free gift each year up to the $14,000 lim­it ($28,000 for joint gifts). 

How­ev­er, col­leges will often reduce a student’s insti­tu­tion­al finan­cial aid by the amount of the grandparent’s pay­ment.  So before send­ing a check, ask the col­lege how it will affect your grandchild’s eli­gi­bil­i­ty for col­lege-based aid.  If your con­tri­bu­tion will adverse­ly affect your grandchild’s aid pack­age, par­tic­u­lar­ly the schol­ar­ship or grant por­tion, con­sid­er gift­ing the mon­ey to your grand­child after grad­u­a­tion to help him or her pay off stu­dent loans.  

 

529 Plans

A 529 plan can be an excel­lent way for grand­par­ents to con­tribute to a grandchild’s col­lege edu­ca­tion, while simul­ta­ne­ous­ly par­ing down their own estate.  Con­tri­bu­tions to a 529 grow tax deferred, and with­drawals used for the beneficiary’s qual­i­fied edu­ca­tion expens­es are com­plete­ly tax free at the fed­er­al lev­el (and gen­er­al­ly at the state lev­el too).  

There are two types of 529 plans: col­lege sav­ings plans and pre­paid tuition plans.  Col­lege sav­ings plans are indi­vid­ual invest­ment-type accounts offered by near­ly all states and man­aged by finan­cial insti­tu­tions.  Funds can be used at any accred­it­ed col­lege in the Unit­ed States or abroad.  Pre­paid tuition plans allow pre­pay­ment of tuition at today’s prices for a lim­it­ed group of col­leges– typ­i­cal­ly in-state pub­lic col­leges – that par­tic­i­pate in the plans.  

Grand­par­ents can open a 529 account and name a grand­child as ben­e­fi­cia­ry (only one per­son can be list­ed as account own­er, though) or can con­tribute to an already exist­ing 529 account.  Grand­par­ents can con­tribute a lump sum to a grandchild’s 529 account, or they can con­tribute small­er, reg­u­lar amounts. 

Regard­ing lump-sum gifts, a big advan­tage of 529 plans is that under spe­cial rules unique to 529 plans, indi­vid­u­als can make a sin­gle lump-sum gift to a 529 plan of up to $70,000 ($140,000 for joint gifts by mar­ried cou­ples) and avoid fed­er­al gift tax.  To do so, a spe­cial elec­tion must be made to treat the gift as if it were made in equal install­ments over a five-year peri­od, and no addi­tion­al gifts can be made to the ben­e­fi­cia­ry dur­ing this time.  

Sig­nif­i­cant­ly, this mon­ey is con­sid­ered removed from the grand­par­ents’ estate, even though in the case of a grand­par­ent-owned 529 account the grand­par­ent would still retain con­trol over the funds.  There is a caveat, how­ev­er.  If a grand­par­ent were to die dur­ing the five-year peri­od, then a pro­rat­ed por­tion of the con­tri­bu­tion would be “recap­tured” into the estate for estate tax pur­pos­es. 

If grand­par­ents want to open a 529 account for their grand­child, there are a few things to keep in mind.  If you need to with­draw the mon­ey in the 529 account for some­thing oth­er than your grandchild’s col­lege expenses—for exam­ple, for med­ical expens­es or emer­gency purposes—there is a dou­ble con­se­quence:  the earn­ings por­tion of the with­draw­al is sub­ject to a 10% penal­ty and will be taxed at your ordi­nary income tax rate.  Also, funds in a grand­par­ent-owned 529 account may still be fac­tored in when deter­min­ing Med­ic­aid eli­gi­bil­i­ty, unless these funds are specif­i­cal­ly exempt­ed by state law. 

Regard­ing finan­cial aid, grand­par­ent-owned 529 accounts do not need to be list­ed as an asset on the fed­er­al Healthy Wealthy and Wise womengovernment’s finan­cial aid appli­ca­tion, the FAFSA.  How­ev­er, dis­tri­b­u­tions (with­drawals) from a grand­par­ent-owned 529 plan are report­ed as untaxed income to the ben­e­fi­cia­ry (grand­child), and this income is assessed at 50% by the FAFSA.  By con­trast, par­ent-owned 529 accounts are report­ed as a par­ent asset on the FAFSA (and assess at 5.6%) and dis­tri­b­u­tions from par­ent-owned plans aren’t count­ed as stu­dent income.  To avoid hav­ing the dis­tri­b­u­tion from a grand­par­ent-owned 529 account count as stu­dent income, one option is for the grand­child to delay tak­ing a dis­tri­b­u­tion from the 529 plan until any time after Jan­u­ary 1 of the grandchild’s junior year of col­lege (because there will be no more FAF­SAs to fill out).  Anoth­er option is for the grand­par­ent to change the own­er of the 529 account to the par­ent.  

Col­leges treat 529 plans dif­fer­ent­ly for pur­pos­es of dis­trib­ut­ing their own finan­cial aid.  Gen­er­al­ly, par­ent-owned and grand­par­ent-owned 529 accounts are treat­ed equal­ly because col­leges sim­ply require a stu­dent to list all 529 plans for which he or she is the named ben­e­fi­cia­ry.  

 

Private Elementary/Secondary School

If you’re inter­est­ed in con­tribut­ing to your grandchild’s pri­vate ele­men­tary or sec­ondary school edu­ca­tion, a Coverdell edu­ca­tion sav­ings account (ESA) is worth a look.  You can con­tribute up to $2,000 per ben­e­fi­cia­ry each year to a Coverdell ESA.  Like funds in a 529 plan, mon­ey in a Coverdell ESA grows tax deferred and is tax free at the fed­er­al and state lev­el if used to pay the beneficiary’s qual­i­fied edu­ca­tion expens­es, which includes col­lege along with pri­vate ele­men­tary and sec­ondary school.  How­ev­er, there are income lim­its on who can con­tribute to a Coverdell ESA—married cou­ples with mod­i­fied adjust­ed gross income over $220,000 ($110,000 for indi­vid­u­als) can­not con­tribute.  

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