Allworth Co-CEO Scott Hanson shares a few ways to help fund a grandchild's post-secondary tuition.
Do you have grandchildren?
Paying for their college is not unlike saving for retirement.
That’s because, as with preparing for retirement, what with its saving and tax-deferred accounts, paying for a grandchild’s tuition isn’t a straight-up dollar-for-dollar endeavor.
The fact is, that in our ever-more-complex financial world, there are ways to fund a loved-one’s education so that you can receive a tax break (or two) along the way. Just remember, before you offer to foot the bill for a grandchild’s education, not only must you be absolutely certain that you have enough money to pay for your own retirement, but at this stage of life, financial mistakes are difficult to overcome, so speak with your advisor and your accountant before committing to this generous but expensive undertaking.
With that in mind, here are three things you could do to pay for a grandkid’s college education.
Let’s start with the basics: Your granddaughter wants to go to an expensive private school, and you want to help. And so, as a high school graduation present, you decide to give her a check to pay for some of her upcoming expenses.
While writing a check may seem like the most direct route, there are several tax considerations.
First, depending on how much you give, there’s the federal yearly gift tax exclusion maximum of $15,000 ($30,000 for couples). (Translation: This is the max you can give without triggering a federal gift tax event.)
Second, for those folks with large estates, there’s the lesser-known tax implications of the "generation-skipping tax" (GST), which is also sometimes known as the generation-skipping transfer tax. Developed in 1976, the GST is an added tax imposed upon large financial gifts given to someone who is more than 37.5 years younger than you. It was developed to keep folks with large estates from bypassing a generation of estate and gift taxes by giving money directly to a much younger relative. In this scenario, the beneficiary is referred to as a “skip person” because the gift (and estate taxes) skipped a generation.
Next, when giving cash directly, a well-intentioned gift of cash could also be counted as untaxed income for the recipient, which might affect their student loan eligibility.
If, for any reason (say, you just love the linear concept of writing a check), you decide to give your grandchild money to pay for college, consider giving it to their parent(s), instead. (That way, it won’t need to be reported as income on the student loan application.)
Lastly, a potentially simpler option for those who insist on giving cash is to simply wait and pay your grandchild’s student loans once they graduate from college.
I typically like this approach better than directly paying the student cash. No matter how much the tuition is, paying it directly isn’t considered a gift, so there’s no adverse tax implications for your grandchild. Also, directly paying his or her tuition helps you bypass the $15,000 federal gift tax exclusion. And paying the school directly not only has the added inducement of ensuring that your money is going directly for the educational purposes you intend (kids will be kids), it also means that if you still want to give some cash, you’re free to also give the aforementioned yearly tax-free gift of up to $15,000 (or up to $30,000 for couples).
Just remember: the scholarship or grant departments at some universities will reduce your grandchild’s financial aid in the amount of the tuition you have paid. (This is another scenario where it might be better to wait until after they graduate, and then assist with paying off any student loans.)
If you’re committed to helping pay for a grandchild’s college education, then the venerable 529 Savings Plan has a lot of advantages.
There are two types of 529 plans: Prepaid Tuition plans and the substantially more popular Savings Plans. A 529 Savings Plan is where you direct your money toward one of the plan’s investment portfolios (not unlike you would with a 401(k)). These funds should grow over time and can be used to pay qualified college expenses including books and tuition, but also room and board. The second 529 is the less popular Prepaid Tuition Plan version, which allows you to buy credits that lock-in today’s tuition prices, even though your grandchild might not attend college for years or even decades. (Be aware that the number of colleges who participate in these plans is limited).
As a method for paying for college, 529 Savings Plans are also versatile investment vehicles. That’s because money placed in a 529 not only grows tax deferred, but once the money is needed, it can be withdrawn free from federal taxes (and, typically, from state taxes, as well). The stipulation is that the money be exclusively used to pay for qualified educational expenses. Another advantage of a 529 is, that if the child who you established the plan for eventually decides not to go to college, or she receives a full scholarship and doesn’t need the money, you can switch the 529 beneficiary to another grandchild (or any other family member, for that matter) with absolutely no penalty.
Lastly, with lifetime contribution limits of several hundred thousand dollars (it varies by state), a 529 Savings Plan is also a terrific way to reduce the size of a large estate.
How does it work? Logistically, you, as the grandparent (only one person can “own” the account), fund a 529 account (potentially depositing up to $75,000 a year every five years for a single person, $150,000 for a couple) and then list the grandchild as the named beneficiary. You can contribute the money via a lump sum, but, for tax purposes, could also “spread” the lump sum payment deduction over five years.
Now (and you knew there’d be a “now”), if you do in fact fund a 529 and find that you need the money for an emergency, the growth interest you’ve accrued in the account will not only be taxed as ordinary income, but you’ll get hit with a 10 percent penalty (which is yet another way that a 529 is similar to a 401(k)).
On the other side of the financial spectrum, for those who perhaps have graciously funded a 529 but who later suffer a serious financial setback, the money in the 529 (depending on your state) could impact your eligibility for Medicaid.
While I haven’t come close to listing all the various pros and cons of 529 Savings Plans, with tax deferred growth, your choice of investments, and large contribution limits, all things considered, these are extremely versatile vehicles. However, aside the fact they exist to pay for college, the rules and laws pertaining to them are complex and they require a lot of financial “blending” and planning.
Simply, their viability depends on your overall financial situation, but if you have a grandchild and you want to help them pay for college, and you can afford it, 529s are certainly worth having a conversation about with your advisor.