It’s definitely not our grandparents’ college education anymore. Since 1987, long after today’s grandparents had graduated, college costs have grown astonishingly. Back then, attending a public university cost about $1,500—$3,200 in today’s dollars. Today, the average cost of a college education has skyrocketed to more than $35,000, a nearly 300% increase!
Grandparents today must be bewildered that, on average, nearly 70% of students leave school with an average of $30,000 in student loan debt. Most grandparents wouldn’t wish that fate on their grandkids, and many are stepping up to help cover college expenses.
However, before opening your wallet, it’s critical to understand the implications of your benevolence. While there are several ways to help with your grandchild’s college education, they can have a consequential impact on your finances and your grandkid’s ability to qualify for federal student aid.
Direct Financial Contributions
The most straightforward way to assist your grandkids is through direct contributions that can be used for college savings or applied directly to higher education expenses, such as tuition, fees, books, and living expenses.
Annual Gifting
The IRS allows you to give up to $18,000 annually per grandchild without triggering federal gift taxes. A married couple can give up to $36,000 annually. Financial gifts from grandparents must be reported on FAFSA, so there will be no negative impact on the student’s financial aid eligibility.
Contribute to a 529 College Savings Plan
A 529 College Savings Plan is an excellent option for grandparents with young grandchildren. The funds contributed to the plan are allowed to accumulate tax-free, and they can be withdrawn tax-free if they are used to pay for qualified college or K-12 education expenses. You can also check with your state to see if they offer a tax deduction or credits for 529 plan contributions.
As with a direct gift, you can contribute up to $18,000 ($36,000 per couple) free of federal gift taxes. If you need to play catch-up, you can frontload the account with up to $90,000, free of gift taxes. However, you won’t be able to make additional gifts for five years.
If unused funds remain in a funded 529 plan, they can also become a generous legacy gift. Those funds can be rolled over to a Roth IRA, which the grandchild can use for retirement savings or home purchases.
Fund an Education Savings Account
As an alternative, Education Savings Accounts (ESAs), also known as Coverdell Education Savings Accounts, offer the same tax incentives as a 529 plan. These accounts can be established as brokerage accounts with many more investment options. They also may be more appealing if you want to create a particular asset allocation strategy with more diversification.
Like 529 plans, funds from an ESA can be withdrawn tax-free to cover qualified education expenses for K-12 and secondary education.
The downside is that ESAs are limited to a $2,000 annual contribution from any family member who wants to contribute. Also, the ability to contribute to an ESA is phased out for higher earners, starting at $100,000 for individuals and $200,000 for married couples.
Direct Tuition Payment
Another workaround to the annual gift tax exclusion is to pay tuition directly to the educational institution your grandchild is attending. Direct tuition payments are not counted as taxable gifts, meaning you can pay unlimited amounts for tuition without triggering gift taxes. The unlimited gift tax exclusion does not apply to books or living expenses.
Check with the educational institution before making any tuition payments, as some may treat them as cash support, which can affect financial aid eligibility.
Pay off Your Grandchild’s Student Loan
If your grandchild has taken out student loans, you can help get their post-graduate life off to a great start by paying them off. As this would be considered a taxable gift, you should only pay off an amount each year that doesn’t exceed the annual gift tax exclusion of $18,000 (36,000 per married couple).
Setting Up Trusts
For grandparents with substantial assets, setting up a trust can be an effective way to help with your grandkid’s education while also giving you some control over how the funds are used. There are various types of trusts, each with its own benefits and complexities.
Educational Trusts
Educational trusts are specifically designed to pay for education-related costs, including room and board, tuition, and books, as specified by the grantor grandparent. The grantor can also specify conditions for accessing the funds, such as timing and amounts.
Though they offer tax benefits under certain circumstances, educational trusts require expert planning and administration.
Irrevocable Trusts
If estate planning and minimizing taxes are considerations, you could use an irrevocable trust. These are more rigid but offer the benefit of removing assets from the grandparent’s taxable estate, potentially reducing estate taxes. Once your assets are placed in the trust, you lose control over them. However, you can ensure that the funds are used solely for the grandchild’s education.
Custodial Accounts
Another option is to set up a custodial account under the Uniform Transfers to Minors Act (UTMA) or Uniform Gifts to Minors Act (UGMA). These accounts allow you to transfer assets to a minor grandchild without establishing a formal trust.
However, once they reach the age of majority (18 in most states), they gain complete control over the account, which might not align with your intentions for educational use.
Provide Loans or Loan Guarantees
If you’re concerned about your financial security, you could loan funds for college expenses instead.
Intra-Family Loans
One option is to arrange intra-family loans with your grandkids or their parents. A formal loan agreement would specify an interest rate and repayment schedule while avoiding any complications with the IRS.
Loan Guarantees
You could also co-sign or guarantee a student loan, allowing your grandkid to qualify for loans they might not be able to obtain on their own due to a lack of credit history.
However, it’s essential to understand that you can become liable if your grandchild cannot make the loan payments. It’s crucial to weigh these risks and consider the impact on your financial situation.
Leveraging Tax Strategies
You can also utilize various tax strategies to maximize the financial support you provide for your grandchild’s education.
Tax-Free Gifts for Education
As mentioned, paying tuition directly to the institution allows you to give unlimited amounts without incurring gift tax. This is a powerful strategy to make significant contributions without affecting your lifetime gift and estate tax exemptions.
Charitable Remainder Trusts (CRTs)
If you’re philanthropically inclined, a charitable remainder trust (CRT) can help you achieve two important goals. When you establish a CRT, you can donate assets to the trust for an immediate tax deduction and designate a portion of the income from the trust to pay for your grandkid’s education. After your death, the remaining assets go to a designated charity.
What’s the Impact on Financial Aid?
While helping with college expenses is generous, it’s essential to consider the potential impact on the grandchild’s financial aid eligibility. Contributions from grandparents can affect the amount of financial aid a student is eligible to receive.
- Financial gifts: The new FAFSA does not ask about cash gifts from grandparents. As such, they are not considered taxable gifts and will not reduce aid eligibility.
- 529 plan contributions: Under new FAFSA rules, neither contributions made to a grandparent-owned 529 plan nor withdrawals made by the student are reported to FAFSA. That’s a significant advantage over a parent-owned plan, which would be counted as a student asset with the potential to reduce their financial aid eligibility.
- Education savings accounts: Because the parent owns the ESA account, accumulated funds do not count toward financial aid eligibility.
- Direct tuition payments: Direct payments to an educational institution are not considered financial gifts. However, some colleges may classify them as gifts for FAFSA purposes. Check with the college before making a payment.
- Trusts and custodial accounts: Most trusts can impact financial aid eligibility, depending on the type and who controls it. Assets in an irrevocable trust are owned and controlled by the trust, so they would not be reported to FAFSA as assets of the grandchild named as a beneficiary. However, income the trust distributes to benefit the student would be considered untaxed income reportable on FAFSA.
One exception to the impact on student aid is a special needs trust set up to benefit a child with a disability. The trust’s assets and income are not reportable on the FAFSA.
Long-Term Legacy Planning
Helping your grandchild get a college education can be part of a broader strategy to create a legacy that will impact future generations.
Estate Planning
Helping your grandkids pay for their college education can be integral to your estate plan. Financial gifts remove assets from your estate, keeping them from being taxed after your death.
You may make as many financial gifts—up to $18,000 annually—as you like each year until you reach the lifetime gift tax exclusion threshold of $13,610,000 ($27,220,000 per couple). Gifts made after reaching that threshold are taxed at 40%.
It’s important to note that the lifetime exclusion increased substantially in 2017 but is scheduled to revert to around $6,000,000 after 2025.
Creating a Family Education Fund
Some families establish a dedicated college fund that benefits multiple generations. The fund can be structured to support the current generation of grandchildren and future generations, creating a lasting legacy of education and opportunity.
Balancing Generosity with Financial Security
Helping to pay for your grandchildren’s education is one of the more generous acts of love, but it is a significant commitment. It’s crucial to have a well-conceived plan that balances your generosity with personal financial security.
Assessing Financial Capacity
Work with a financial advisor to carefully assess your financial situation before committing to large contributions. It’s critical to ensure that your financial support for your family doesn’t jeopardize your retirement savings or overall financial health.
Working with an advisor ensures your desire to help your grandkids aligns with your financial goals.
Open Family Communication
Before embarking on any plan to provide financial support, opening a line of communication with the grandkids and their parents is essential. Discussing the level and type of support you are willing to provide is critical to setting expectations and ensuring everyone is on the same page.
This transparency can prevent misunderstandings and ensure that your grandkids’ goals are met in a way that benefits the entire family.
Bottom Line
As a grandparent, you play a unique and invaluable role in your grandchildren’s lives. Contributing to their college education is one of the most impactful ways to secure their future. Whether through direct financial contributions, establishing trusts, or strategically planning to minimize the impact on financial aid, there are numerous ways to help.
By carefully considering your financial situation with your financial advisor and discussing your plans with family members, you can select the optimal option for you and your grandkids and start enjoying the fruits of your legacy.
The financial advisors at ARQ Wealth have decades of experience in college planning and all the resources you need to start helping your grandkids today.
