It seems like one minute you’re proudly holding your new grandchild in your arms, and the next they’re heading off to college. As the College Board’s annual report, ‘Trends In College Pricing’ highlights, that college experience comes with a high price tag nowadays. If supporting your grandchild’s academic success is important to you, here are 6 ways you can help with your grandkid’s college costs.
1) Cash Gifts To Your Grandchild
You can make an outright gift of cash to your grandchild to help with college costs. For 2019, the annual Federal gift tax exclusion allows you to gift to any one person up to $15,000 if you’re single, and $30,000 as a married couple. Gifting over this amount may trigger tax consequences, including the generation-skipping tax (GST), imposed on gifts to anyone more than one generation younger than you.
However, be aware that your cash gift must be reported as untaxed income on your grandchild’s Free Application for Federal Student Aid (FAFSA). This might impact their eligibility for Federal student aid, need-based assistance from the college, or certain scholarship or grant opportunities.
Instead, you might consider waiting until after your grandchild files their last FAFSA in junior year, after which your gift may have less financial impact, or make a graduation gift of cash to help pay off outstanding college costs e.g., student loans.
2) Cash Gifts To Your Grandchild’s Parents
The same cash gift can also be made to your grandchild’s parents to help with your grandkid’s college costs, as parents don’t need to report such gifts as income on the FAFSA (although they are included as assets). However, bear in mind that this reduces the amount of any gifts you can make to the parents under the gift tax exclusions above.
3) Payments To The College Directly
Making direct payments to your grandchild’s college can be advantageous:
- Payments made directly to an educational institution aren’t considered taxable gifts, so you can gift as much as you want, and still give your grandchild a tax-free annual gift up to the Federal tax exclusion limits.
- The money is removed from your estate, helping to reduce future taxation.
- The funds are used for their intended purpose.
However, disadvantages include:
- Even if the college has non-profit status, your payments can’t be considered charitable contributions for tax purposes.
- Payments are limited to tuition fees only.
- Colleges often reduce institutional financial aid packages by the amount you gift.
4) Establish A 529 Plan To Help With Your Grandkid’s College Costs
There are two types of 529 plan available:
• College Savings Plans
Offered by most states, funds can be used at any accredited college in the US or abroad.
• Prepaid Tuition Plans
These accounts allow prepayment of tuition at today’s prices. However, not all colleges participate.
Each grandparent can open a 529 account for each grandchild as beneficiary. Funds can be reassigned without penalty if unused e.g., if your grandkid receives a scholarship, you can name another grandchild as account beneficiary. Funds grow tax-deferred, and withdrawals for qualified expenses are tax-free at the Federal (and often, state) level.
Many states allow residents an income tax deduction for 529 contributions. While you can invest in another state’s 529 plan, you won’t reap any state resident tax advantage.
Contributions can be made as regular deposits or as a lump sum. Under special rules, you can pre-fund a 529 plan with a single lump-sum gift of up five times the annual gift tax exclusion i.e., for 2019, $75,000 if you’re single or $150,000 for married couples. A special election allows you to treat the lump sum as five year’s worth of gifts, thereby avoiding Federal gift tax. This approach can be advantageous if you’ve experienced a high-income year. However, you can’t make further gifts into the 529 fund until the five year period expires. Furthermore, if you pass away during the five-year period, a prorated portion of your contribution returns into your estate for estate tax purposes.
Unlike custodial accounts, where the balance passes to the minor automatically upon attaining age of majority (which varies by state), you retain control of funds in any 529 plan you own. Consider the following before establishing a 529 plan to help with your grandkid’s college costs:
- The funds may adversely impact your Medicaid eligibility (unless exempted by state law).
- You can withdraw 529 funds at any time, including for your own use in an emergency. However, when not used for educational expenses, tax penalties apply.
- Because a 529 plan is an investment vehicle, evaluate the risks, fees, etc. before investing. Such information is available in each issuer’s official statement.
5) Contribute To A Parent-Owned 529 Plan
Your grandchild may already have a 529 account established to which you can contribute.
Parent-owned versus grandparent-owned 529 accounts are typically treated the same by a college for purposes of determining college-based financial aid offering. Your grandchild simply reports all 529 plans for which they’re a named beneficiary.
However, FAFSA treatment differs. While your grandchild doesn’t need to list your 529 account as an asset on the FAFSA, distributions must be reported as untaxed income and are assessed at 50% by the FAFSA. In contrast, parent-owned 529 accounts must be reported as assets on the FAFSA, but distributions aren’t counted as student income.
How best to structure ownership of, and contributions to, a 529 account depends upon your personal financial and tax considerations. In some instances, you may choose to transfer ownership of your 529 account to your grandchild’s parent.
6) Consider A Coverdell Education Savings Account (ESA)
Previously, the main advantage of establishing a Coverdell ESA was that funds could be used to pay for your grandchild’s elementary or secondary school costs. In contrast, 529 plans were formerly limited to college costs only.
However, recent tax reform means that you can now pay up to $10,000 per year from a 529 plan for K-12 educational costs.
As a result, the annual contribution limits (up to $2,000 per beneficiary for 2019) and income limits for contributors (contributions phase out completely at $110,000 modified adjusted gross income for individuals, and $220,000 for married couples) make a Coverdell ESA a less attractive, less flexible option for most grandparents seeking to support their grandkid’s college costs.
If family gifting is an important element of your broader wealth strategy, then helping with your grandkid’s college costs is a worthy endeavor. SageVest Wealth Management can help you determine how much to give and the best approach, relative to your own financial wellbeing. Contact us to learn more.