May 06, 2022 | money-management
College Funds for Grandkids: How to Contribute
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.
But what’s the best way to contribute to your grandchild’s education? Should you open a college savings plan or just cut a check when it comes time to pay tuition? Let’s take a look at some of the best ways to help.
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How to Contribute to College Funds for Grandkids
Here are some different ways that grandparents can contribute financially to their grandchild’s future.
A 529 plan can be an excellent way for grandparents to contribute to a grandchild's college or graduate school education.
Contributions to this college fund grow tax deferred, and withdrawals used for the beneficiary's qualified education expenses are completely tax free at the federal level. Participation in a 529 plan isn't restricted by income level and lifetime plan contribution limits are high.
Grandparents can open a 529 account and name a grandchild as beneficiary (only one person can be listed as account owner, though) or they 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 $80,000 and married couples can make a joint gift of up to $160,000 (which is five times the annual gift tax exclusion) 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.
Money in a 529 plan 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.
Types of 529 Plans
There are actually two types of 529 plans: savings plans and prepaid tuition plans.
A 529 savings plan is an individual investment account where you direct your contributions to one or more of the plan's investment portfolios, similar to a 401(k) plan. Funds in the account can be used to pay total qualified expenses (i.e., tuition, fees, room and board, books, supplies) at any accredited college in the United States or abroad. Funds can also be used to pay K-12 tuition expenses, up to $10,000 per year.
By contrast, the less-common 529 prepaid tuition plan allows you to purchase college tuition credits at today's prices for use in the future at a limited group of colleges that participate in the plan, typically in-state public colleges.
Coverdell Education Savings Account
A Coverdell ESA is another type of education plan that can be used to cover a child or grandchild’s qualifying education expenses. These accounts can be set up at a bank or brokerage firm, grow tax-deferred, and are tax-free upon withdrawal at the federal (and generally, state) level when used to pay for educational expenses.
Contributions made to this type of college fund must be made before the beneficiary reaches 18 years of age, and the maximum contribution per beneficiary is only $2,000.
To contribute to a Coverdell college savings account, your modified adjusted gross income must be less than $110,000 (or $220,000 if married, filing jointly). In addition to college expenses, a Coverdell can be used towards eligible K-12 expenses
Paying Tuition Directly to the College
Instead of contributing to a college savings account, you can opt to just pay for tuition directly.
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 annual federal gift tax exclusion.
However, payments can only be made for tuition— room and board, books, fees, equipment, and other similar expenses don't 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. On top of the tuition that you pay, you are still free to give your grandchild a separate tax-free gift each year up to the $16,000 limit ($32,000 for joint gifts).
Keep in mind that 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.
A common way for grandparents to help grandchildren with the high cost of a college education is to make an outright gift of cash or securities.
While this may seem like the easiest method, it has a couple of drawbacks. For one, a gift of more than the annual gift tax exclusion amount — $16,000 for individual gifts and $32,000 for gifts made by a married couple in 2022 — might have gift tax and generation-skipping transfer tax (GSTT) consequences.
Another drawback is that a cash gift to a student will be considered untaxed income by the federal financial 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.
Still, a gift of $16,000 a year can be substantial to a college student. As they say— any little bit helps!
Planning Ahead for the Future
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. However, simply writing your grandkids a check isn’t necessarily the only route that you can take. Knowing your college fund options can help you determine tax-efficient options that are advantageous to both you and your future college student.
*Non-deposit investment products and services are offered through CUSO Financial Services, L.P. ("CFS"), a registered broker-dealer Member FINRA/SIPC and SEC Registered Investment Advisor. Products offered through CFS: are not NCUA/NCUSIF or otherwise federally insured, are not guarantees or obligations of the credit union, and may involve investment risk including possible loss of principal. Investment Representatives are registered through CFS. The Credit Union has contracted with CFS to make non-deposit investment products and services available to credit union members.
Prepared by Broadridge Investor Communication Solutions, Inc. Copyright 2018.
Talk to a CFS* Financial Advisor
Need more guidance on contributing to college funds? Schedule a Amplify Wealth Management appointment with our colleagues at CUSO Financial Services (CFS).