By Jean Gruss
Many college graduates begin their professional lives with the heavy burden of student loan debt, but grandparents with the desire and the means can help younger generations get off to a more financially secure start. There are some effective ways to help a grandchild pay for college, including plans that have tax benefits for parents and grandparents.
Start College Savings Early
Starting a savings plan for grandchildren early in their lives can provide a big boost when they enter college. Instead of gifting toys or cash, consider making college-fund contributions on holidays or birthdays. While they may not appreciate your gift when they’re young, your grandchildren will be grateful when they become university students.
Weigh all of the options before making any contributions. Any financial gifts must be considered in the context of retirement and estate planning. It’s a good idea to discuss the overall strategy with your family and financial advisers. “It’s important to coordinate the savings plan with the student’s parents,” says Julie Virta, a senior financial adviser with Vanguard Personal Advisor Services in Malvern, PA. Understanding the income rules regarding the Free Application for Federal Student Aid (FAFSA) is an important starting point for all families considering paying for college. You’ll want to make sure gifts don’t impact a student’s financial aid application.
See the Results of Your Giving
Many individuals are choosing to begin giving during their lifetime, rather than waiting for the end of life. Not only does lifetime giving allow the giver to see the results of the gift, but paying down assets may make good sense as an estate-planning strategy. “In some cases, especially for those with significant wealth, it may make sense to pay for that college education directly,” says Virta. “That gets more dollars out of the estate.”
Send checks directly to the school’s financial office or bursar to avoid giving your grandchild a check for the tuition, or room and board. The benefit of directly paying the educational institution is the ability to avoid gift taxes. If you prefer an additional level of accountability by your grandchild, you might make it known that tuition payments are contingent upon good grades or their need to work part-time to help pay for the education costs.
Individual Account Options
Some grandparents establish brokerage accounts for minors that are intended to pay for college. Monetary gifts for holidays or birthdays can be contributed to such accounts, called custodial accounts under the Uniform Gift to Minors Act (UGMA) or Uniform Transfers to Minors Act (UTMA).
If you decide to open a brokerage account for a young grandchild, consider that it will be identified as a personal asset on their financial aid application. Also to be considered is the fact that grandchildren can spend the funds any way they choose once they reach the age of majority and are able to take control of the account. This age is 21 in most states, but depends on the minor’s state of residence and whether the account is an UGMA or UTMA. Once they have ownership of the funds, they don’t have to comply with your wishes to use the gift to pay for their education.
For estate-planning purposes, it might be more beneficial to establish trusts instead of custodial accounts. This option allows you more control over the money, including whether and when a child might have access to the funds.
An additional option is a Coverdell Education Savings Account (ESA). The low annual contribution limit ($2,000) combined with income limits ($110,000 for an individual and $220,000 for taxpayers filing jointly) are very restrictive. For this reason, most financial planners prefer the 529 plans described below.
Advantages of 529 Plans
One of the most popular ways to save for college is the 529 qualified tuition plan. Almost every state offers a plan, and some offer more than one. Fees on investment plans vary widely, so it pays to shop around. A good website to start your search is Saving for College (www.savingforcollege.com), which features a useful tool that lets you compare different 529 plans.
The two types of 529 plans are savings plans and prepaid plans. The benefit of a 529 savings plan is that the money can be used to pay for any eligible college expenses anywhere. Unlike a prepaid plan for a specific state or university, your grandchild will benefit as long as they choose to attend an eligible educational institution.
Neither you nor your grandchild must live in the state from which you pick a 529 savings plan, but there are some residency requirements for prepaid plans. Consider your home state first if it offers a state income-tax break. Most states that levy a state income tax let you deduct a certain amount for contributions to that state’s 529 plan.
Money inside the plan grows free of federal and usually state income taxes, so it pays to start early in your grandchild’s life. When you withdraw the funds to pay for college expenses, such as tuition or room and board, the value is not subject to federal or state income taxes. Eligible expenses may also include education at vocational and graduate schools. “Be careful not to overfund the account,” counsels Virta. Earnings that don’t get used for education will be taxed and subject to a penalty. However, any unused money can be rolled over for the benefit of another grandchild or eligible family member.
Grandparents who establish a 529 plan control the account because they own it, so even after the beneficiary becomes an adult, the account owner still decides how and when to distribute the funds. Well planned distributions can have less impact on a grandchild’s financial aid applications.
Regardless of how you decide to help pay for college, your grandchildren and their parents will undoubtedly appreciate the meaningful gift.