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Helping to pay for college education is one of the best gifts grandparents can give their grandchildren. As the cost of a college education continues to increase, many grandparents are stepping in to assist. If done correctly, this is also a great way to pass on wealth without having to pay gift and estate taxes. This article will highlight some of the common options for grandparents.
Outright Gifts
Under the current tax rules, a grandparent can give up to $13,000 annually to a grandchild free from estate tax or gift tax ($26,000 per grandchild if both grandparents contribute). This method is simple and easy, but it has some drawbacks. First, you are giving up control of the funds to your grandchild, who could use them for a purpose other than college. Another drawback is an outright gift becomes an asset of the grandchild, which could reduce the amount of available financial aid. Federal financial aid formulas require students to contribute 20% of their assets each year toward college costs. Alternatively, an outright gift to the parents for their child’s education may be preferable, since parents are expected to contribute a maximum of 5.6% of their assets toward their child’s college costs.
Pay Tuition Directly
A great way to help pay for college costs is to pay the college directly. Tuition payments made directly to the college are not considered taxable gifts, no matter how large the payment. However, this applies only to tuition costs – room and board, books and other fees are not considered qualified expenses for this treatment. Direct payment of tuition does not count toward the $13,000 annual gift tax exclusion, so in addition you would be able to give your grandchild a tax-free gift up to $13,000 per year. Another advantage over the outright gift is that this method will ensure the funds are used for college. One drawback is the college may reduce the student’s financial aid by the amount of the payment. If this is a consideration, you should check with the college to see how a direct payment may affect eligibility for school-based aid.
529 College Savings Plan
This can be an excellent way for grandparents to assist with financing a grandchild’s college education. A 529 college savings plan is a state-sponsored plan that invests the money on behalf of the participants. Under current law, contributions to the plan grow tax-deferred, and withdrawals that are used for qualified education expenses are tax-free. Qualified expenses include tuition, room and board (must be enrolled at least half time), books and fees. It is important to note, however, that if funds are used for something other than qualified education expenses, the earnings portion will be charged a 10% penalty and taxed at your ordinary income tax rate. Grandparents can open an account and name a grandchild as beneficiary, or they can contribute to an existing account. One advantage unique to 529 plans is that a donor can consolidate five years worth of tax-free investing into a single year ($65,000 lump sum gift by an individual; $130,000 joint gift by married couples), as long as they don’t make additional gifts to the beneficiary in the five-year period. This allows for investing a lot of money up front that can grow for the grandchild. The funds can be used for any accredited college. You can join any state’s plan, but there are often state tax benefits, such as deduction for contributions, which provide an incentive to participate in your in-state plan. View the other advantages of a 529 college savings plan below.
Help with college costs is a wonderful gift to give a grandchild. Before giving away your assets, however, it is critical to ensure that your own goals and lifestyle expenses are adequately funded. Your grandchild has a number of other options available for paying for college – such as loans, scholarships, financial aid and work programs – and you always have the option of helping to repay loans after they have graduated, if the resources are available. Alternatively, your options for funding a secure and comfortable retirement if your resources have been depleted are limited.
Future changes in tax law will likely affect some of the benefits of these approaches. Feel free to contact a FIM Group financial adviser if you have questions or would like to further explore whether one of these options may be right for you.
