What Grandparents Need to Know About Paying for College
One of the great things about being a financial advisor is the opportunity to experience some joyous events with clients.
“That happened recently when Steve and Beth, whom I’ve been working with for a decade, became first-time grandparents,” said Talia Pierluissi, a director in wealth management and principal at Aspiriant. “They were absolutely thrilled and said they wanted to make a lasting impact on the baby’s future by helping to pay for college.”
They understood that starting to save while their grandchild was still an infant was advantageous. And they knew there were various ways to give money. But they weren’t exactly sure which strategy would be best for everyone in their family.
Steve and Beth had a number of questions: What’s the best way to help pay for education? Should they give money directly to their grandchildren or to the parents? Should they set up their own 529 college savings plan or make gifts to a 529 account owned by the parent? Does a gift from grandparents affect financial aid? Which option provides the greatest tax benefits?
Their questions are common for new grandparents as the labyrinth of college financing is befuddling. The best option usually depends on:
- Their children’s (the grandchild’s parents’) financial situation
- The age of the grandchild
- The likelihood that the grandchild will qualify for financial aid
“I recommend grandparents and their children talk about education and how best to finance college expenses for the grandchild,” Talia added.
When to use a 529 plan
For grandparents with sufficient means, state-operated 529 plans are a tax-efficient way to help fund grandchildren’s college or graduate school expenses. Also, note that the new Tax Cuts and Jobs Act now allows for 529 plans to be used for private K-12 education, up to $10,000 per year.
The funds in a 529 receive tax-free compounding and income is never taxed if used for qualifying educational expenses.
Grandparents can give substantial amounts to 529 plans and still avoid paying a gift tax — now up to $15,000 for 2018 ($30,000 per year for a married couple) or as much as $75,000 ($150,000 for a married couple) at once for a five-year period for each grandchild.
Many Aspiriant clients prefer to make gifts to 529 accounts owned by their children (the parent), for the benefit of their grandchildren. However, if a grandchild is likely to qualify for college financial aid, then more careful planning is necessary.
Gifts can affect financial aid
Just because a family has more financial resources, it doesn’t mean the grandchild won’t be eligible for financial aid. As the average four-year cost of college surpasses $100,000, more than 86% of college students in the U.S. receive some form of financial aid.*
So grandparents should carefully consider how their gifts might affect their grandchildren’s chances for financial aid in the future.
- Gifts made directly to grandchild
Gifts made outright to the grandkids can hurt their chances of getting financial assistance since assets in the name of the student are counted heavily — up to 20% in the Expected Family Contributions (EFC) calculation for the Free Application for Federal Student Aid (FAFSA).
- Gifts made to parents of grandchild
Gifts made to the parents to fund the 529 plans are treated as parental assets and will be counted up to 5.64% in the EFC.
- Gifts in your own 529 plan
The advantage of a grandparent-owned 529 plan is that it does not count as the child’s or the parent’s asset for purposes of FAFSA. The disadvantage, however, is that withdrawals from grandparent-owned 529 plans at the time of college must be added to the student’s adjusted gross income. Since student income is generally assessed heavily in the financial aid formula (up to 50% in excess of the $6,420 annual income allowance) this can negatively affect the student’s ability to receive financial aid. Note that many private colleges use the College Scholarship Service Financial Aid Profile, in addition to FAFSA, and generally these same rules hold.
FAFSA rules and strategies for funding
In earlier years, FAFSA rules looked at income from the previous year when determining financial aid eligibility for the current school year. But as of the 2017-2018 school year, financial aid is based on income two years prior to the year you are applying for. This means that the grandparents’ withdrawals from 529 plans will not affect a student’s financial aid after the sophomore college year.
The treatment of parent-owned 529 accounts did not change under the new rules since withdrawals from parent-owned accounts are not included in the income formula.
Therefore, it’s better for the parents of the children to tap their own 529 plans and savings first, then let the grandparents fund the junior and senior years with their 529 plan funds and other gifts. Similarly, grandparents wishing to use 529 plans to fund graduate school should delay withdrawals until the grandchild’s second year of graduate school.
The new rule makes it easier for parents and grandparents to plan ahead and coordinate funding since students can now submit their financial aid applications as early as October 1, rather than having to wait until January. And they can use actual tax returns from the “prior-prior” year, rather than having to submit estimates, as they had in the past.
Paying colleges directly
Another option for grandparents to consider is making tuition payments directly. As long as the school is a qualified educational institution, tuition payments are considered tax-free transfers and do not fall under the gift tax annual exclusion. This is a great way for grandparents to give more to their grandchildren.
However, if the grandchild is receiving financial aid, these payments should not be made until the junior year, as they are considered cash support and could significantly affect their financial aid award.
529 plans and direct tuition payments are great ways for grandparents to help with their grandchildren’s college education. But make sure to coordinate with the parents on saving for college and when to use the funds to ensure that your grandchild does not lose financial aid eligibility and receives the greatest benefit toward their future success.