There are many ways grandparents can help grandchildren pay for college. These include saving before college, helping during college, and paying back student loans after college.
When When you choose to help your grandchildren cover their tuition costs, you are influencing the options available to you, including those that have tax and financial benefit benefits.
You should carefully compare the pros and cons of each choice available to you in order to minimize tax costs and avoid unnecessary cuts in your grandchild’s right to adequate finances. Here’s what you need to know.
How To Help Grandchildren Save Money On College
Saving for a grandchild’s college education can increase the likelihood that the grandchild will enroll and graduate from college. Why?
First, the grandchild is expected to continue their education early on after high school. Second, spreading college costs over time makes savings easier and has the benefit of compounding them to increase savings more quickly.
How you save can affect the grandchild’s eligibility for needs-based financial assistance. It can also affect federal and state income taxes. There are three specialized college savings accounts that offer tax and financial benefits:
Other savings options include U.S. savings bonds, UGTM or UTMA accounts, Roth IRAs on behalf of the grandchild, and more. Let’s take a look at the pros and cons of each option.
Coverdell Education savings accounts
Coverdell Education Savings Accounts (ESAs) are more limited than 529 plans. They have a total annual contribution limit of $ 2,000 from all sources and there are forfeited income for contributors.
Coverdell ESAs also have age limits: Contributions must end when the grandchild is 18 years old and the money must cost by the age of 30.
Prepaid curricula claim to withhold college tuition fees at current prices. Unfortunately, these promises are often not kept.
Many prepaid curricula suffer from actuarial deficits and are closed to new students. There are only a dozen or so prepaid curricula left.
529 college savings plans
529 college savings plans provide estate planning benefits. Contributions are immediately removed from the contributor’s estate. However, the account holder retains control of the money. Grandparents can donate up to $ 15,000 per grandchild ($ 30,000 if donating as a couple) without incurring gift taxes or any portion of the lifetime gift tax exemption.
Superfunding (five-year gift tax averaging) allows grandparents to give five times as much as a lump sum per beneficiary – $ 75,000 per grandchild ($ 150,000 as a couple) – and have it treated as if it were spread over a five-year period. These estate planning benefits can be especially valuable if the grandparents are wealthy.
The revenues in a 529 plan are accrued for tax relief and are completely tax free when used to pay qualifying education expenses. Two-thirds of states offer state income tax withholding or a tax credit based on contributions to the state’s 529 plan. (Seven states allow the state income tax break for contributions to each state’s 529 plan.)
A 529 plan owned by the grandchild or grandchildren’s parents is treated more cheaply than money in a custodian or brokerage account when applying for a federal student grant (FAFSA) free of charge. Grandparent-owned 529 plans are currently being treated less favorably, but that will change in 2024-25 and there are effective workarounds in place until then. Plus, nothing prevents a grandparent from contributing to a 529 plan owned by a grandson or parent.
US savings bonds
Savings bonds are popular with grandparents who want to help their grandchildren pay for college. Interest on series EE and I savings bonds purchased in 1990 or later is tax-free if the bonds are used to pay for tuition or transferred to a 529 plan (subject to income exit).
However, the grandchild must be dependent on the bond owner to qualify for interest income exclusion. In addition, the interest rates are low. Each grandparent can buy up to $ 10,000 per year in savings bonds. Visit TreasuryDirect.gov for more information.
Custodian or Broker Accounts
Custody accounts such as a UGMA or UTMA account offer limited tax advantages. The first $ 2,200 of unearned income, such as interest, dividends, and capital gains, is taxed at a lower rate than the parent’s income under child tax rules. The first $ 1,100 is tax-free and the second $ 1,100 is subject to the child’s tax rate.
In addition, the unearned income is taxed at the parental rate. However, these accounts are reported to the FAFSA as student assets, reducing the need for on-demand grant entitlement by 20% of the asset. The grandchild also gains control of the account when they reach the age of majority. The money is not intended for tuition fees.
Roth IRA On behalf of the grandchild
Contributing to a Roth IRA owned by the grandchild if the grandchild isn’t going to college is worth considering. It can give the grandchild a head start in saving for retirement. Annual contributions are capped at $ 6,000 in 2021, subject to income limits.
If the grandchild decides to go to college, the money in the Roth IRA will not be reported as an asset with the FAFSA. However, distributions are considered income, including a tax-free premium refund from the Roth IRA. It may be best to wait for the grandchild to graduate from college in order to use the money to pay off student loan debts.
Learn more about paying tuition fees with a Roth IRA >>>
There’s a reason this option was placed at the bottom of the list. Trust funds almost always backfire.
They must be reported as an asset to the FAFSA, even if access to the trust is restricted. The main exception is court-ordered trusts to pay future medical expenses.
Americorps Volunteer Awards
Grandparents could also volunteer with their grandson through Americorps. The education bonuses acquired by the grandparents can be transferred to the grandchildren. These awards can be used to pay college fees or to repay federal student loans.
How To Help Grandchildren Pay For College While Enrolled
When grandparents want to help their grandchildren pay their tuition fees, they should give the money to their parents, not to their grandchildren. Donations to students are considered untaxed income at FAFSA, which reduces the right to need-based help by up to half the donation amount. (This will change from FAFSA 2024-2025.) Gifts to parents will not be reported to FAFSA.
There is a gift tax exclusion for direct payments of college tuition fees under Section 2503 (e) of the Internal Revenue Code 1986. Avoiding gift taxes on a direct payment is often unnecessary because the annual gift tax exclusion of $ 15,000 is usually sufficient. Grandparents can also give the money by putting it into a 529 plan for the student, even if the student is already enrolled in college.
Signing private student loans can be a bad idea as the grandparents may have to repay the loans if the grandchild cannot or will not repay the debt. Lending money to the grandchild or parents can also lead to an awkward situation when the borrower defaults.
Such loans are not eligible for interest deduction on student loans. And if the loan is more than $ 10,000, the grandparents must charge interest at the statutory rate set by the IRS. Even if the grandparents decide to cancel the debt, the canceled amount will be treated as taxable income for the borrower.
A grandparent may be able to claim American Opportunity Tax Credit or Lifetime Learning Tax Credit on amounts paid for tuition and textbooks. However, this would only be the case if the grandchild is legally dependent (e.g. if the grandparent has adopted the grandchild).
How To Help Grandchildren Pay Back Student Loans After College
Finally, it should be noted that after graduation, grandparents can give their grandchildren a gift to repay student loans. This has two potential benefits:
- By waiting until they graduate to finance your grandchildren’s studies, you ensure that your contributions do not affect your entitlement to financial support in line with your needs.
- Promising to repay their student loans can give your grandchildren an incentive to graduate.
If there is money left on a grandchildren’s 529 plan, the account holder can make a qualified distribution of up to $ 10,000 to repay the student loan debt. But note that this is a Lifetime limit per borrower, not according to the 529 plan.