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How Grandparents Can Help Pay for College - Pinnacle Investment Management, Inc.

How Grandparents Can Help Pay for College

October 11, 2016 / Blog


More than 70% of grandparents believe that it is important to help pay for their grandchild’s college education, according to a 2014 study conducted by Fidelity. With the rising costs of college education, the help that grandparents offer can be vital for many families and students. Unfortunately, if not planned for correctly, grandparent help can also do as much harm as good, especially when it comes to financial aid eligibility.

Trying to manage the college process between student, parent, and grandparent can be challenging and it requires coordination between all parties involved.


Understanding Gifting Rules

Before we look into the strategies for grandparents and college funding, lets flesh out the basic tax laws for gifting.

The current gift tax rules allow you to gift $14,000 to any individual each year without having to report it to the IRS. This is known as the “annual exclusion.” There is no limitation to the amount of people you can gift to. So if you had 4 grandkids for instance, you could gift a total of $56,000 to them ($14,000 x 4 grandkids) without any gift tax consequences.

If you are married, your spouse is also eligible for their own $14,000 annual exclusion. So you can give $14,000 to each grandchild and your spouse can give $14,000 to each grandchild.

In addition, there is a special unlimited exemption for tuition payments directly to an educational institution for the student.  Tuition payments made directly to the educational institution (not the student) are free from any gift taxes and are not subject to the $14,000 annual limit. For instance:

Joe is entering his first year of college and his tuition will be $30,000. His grandmother Mary wants to help him with these costs. Mary can pay $30,000 (or less) directly to the school for tuition without any gift tax consequences.

Unfortunately, paying tuition directly to the school can have a severe impact on aid eligibility. There are ways to deal with this by working around the financial aid deadlines. So if you believe your grandchild may be eligible for student aid, you will want to be careful with structuring your gifting and when you complete the gifts.


Custodial Accounts

An easy way to gift money to a child is through the use of a custodial account (UGMA/UTMA). With this account, you can gift money to your grandchild and take the role as custodian, allowing you to control the account until the child reaches legal age. Custodial accounts are very flexible and aren’t restricted to just college expenses.

While this is one of the simplest forms of gifting to your grandchild, it does come with a few qualifications. First, once the child reaches legal age and they have control of the account, they can spend the money on anything of their choosing. There is no restriction on having the money used only towards college expenses.

Second, custodial accounts aren’t very friendly for financial aid purposes. These accounts are counted as student assets on the FAFSA. Student’s assets are assessed at a flat 20% rate. So $20,000 in a UTMA will reduce the eligibility for need based aid by $4,000.

As a contrast, assets that are owned by parents aren’t assessed at nearly as high a level. Parent assets are assessed on a sliding scale, along with an asset protection allowance. The maximum that a parent’s assets can be assessed is 5.64%.

If your grandchild has no chance of getting Financial Aid, then the UTMA/UGMA account can be a great savings vehicle. However, if there is any possibility for aid, you may want to explore the next account instead.


529 Accounts

A 529 College Savings Plan is one of the more powerful college savings vehicles. Money in a 529 grows tax-deferred and withdrawals are tax-free if used for qualified education expenses (i.e. tuition, room and board, and books). Some states also offer a state income tax credit or deduction for contributions into a state sponsored 529.

Most 529 plans have very low minimums so if you wanted to give a $100 birthday present to your grandchild, you could do that in the form of a 529 contribution.

When you open the 529 you can either own the account yourself or the parent can own the account.

From a Financial Aid standpoint, grandparent owned 529 accounts can be a double edged sword.

On the positive side, a 529 in the grandparent’s name is not included as an asset for FAFSA purposes. So if a grandparent had a $100,000 in a 529 for their grandson who is entering college, that student does not need to report the money in the 529 on their FAFSA as an asset.

However (there’s always a however!), while the account itself may not be considered an asset on the FAFSA, any distributions from the 529 will be counted as income of the student. This can reduce aid eligibility by as much as half of the distribution. So if a grandparent takes out $20,000 from a 529 for their grandson’s college, the student’s need-based aid could be reduced by as much as $10,000. This is obviously a severe reduction.

There are opportunities to plan around this. One option is to wait to take distributions from the 529 account until the student’s junior or senior year of college. With the new “prior-prior” FAFSA filing rules (as explained in our prior blog post), grandparents can take distributions in the student’s junior or senior year and those distributions won’t be reported on the FAFSA. You may also be able to look at changing the ownership of the 529 from yourself to the parent of your grandchild. You will want to check with your 529 custodian to see if they allow ownership changes.

Instead of owning the account as a grandparent, you could instead make gifts to a 529 owned by the students parents. In parent owned 529 plans, distributions are not reported for FAFSA purposes. The value of the 529 will be reported as an asset (assessed at a maximum rate of 5.64%) however, that will be much better than having the distribution impact aid by 50%.

Lastly, a potential downside of 529 plans is that they must be used for educational purposes. If not, taxes and penalties may be applied.


Final Thoughts

Outright gifts to your grandchild, paying tuition directly to the school, and 529 plans are just three of the many ways to help your grandchild fund their college education. No matter what you decide, it is important to understand the implications of each and coordinate your efforts with that of the student and their parent.


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About the author

John Shanley: CFP ® is a Financial Advisor with Pinnacle. He joined in 2015 after previously working as a Financial Consultant for Fidelity Investments. John is a Certified Financial Planner, a graduate of Fordham University and is currently pursuing his Masters degree in Financial Services. John is a native of Pawling NY and currently resides in Suffield with his wife, Jennifer, who is an Immigration Attorney. In his free time, John enjoys reading and is an avid hockey fan.

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