By Diana Simeon
The holidays are right around the corner, and grandparents may be trying to decide what to give their grandchildren. Here’s an idea: Help them pay for college. Sure, it may not be as exciting as the latest gadget or other big-ticket item. But when it’s time to pay the tuition bill or repay those student loans, grandparents giving money to grandchildren for college will be much more meaningful.
Grandparents Giving Money to Grandchildren for College
You could save for your grandchild’s college education in a regular savings account, but there’s a better way to do it: a 529 plan. You can think of a 529 like an IRA, but dedicated for college savings. As with an IRA, the money you save in a 529 grows tax-free. Withdrawals are also tax-free, as long as the money is used for qualified education expenses. These include tuition, room and board, books, computers, and other mandatory expenses.
529 plans offer other tax advantages, too. For example, in 2017, Ohio residents contributing to CollegeAdvantage, Ohio’s 529 Plan, can take a deduction of up to $2,000 per beneficiary on their state taxes. “And in 2018, that rises to $4,000 per beneficiary,” says Timothy Gorrell, executive director of the Ohio Tuition Trust Authority, which oversees CollegeAdvantage. And, if you contribute more than $2,000 in 2017 (or $4,000 in 2018) there’s unlimited carry-forward so you never lose the deductibility of the rest of your contribution.
Opening a 529 Plan
Anyone can open a 529 plan. You can make a lump-sum annual contribution or set up automatic monthly contributions. While you can invest in any state’s 529, even if your grandchild has no plan of going to college in that state, it’s best to start your research with your own state’s offering, given the potential tax benefits.
Grandparents can set up their own 529 account, or they can contribute to a 529 account owned by a parent or grandchild. Here’s what you need to know about each option.
Grandparent-owned accounts: You set up the account with your grandchild as the beneficiary. The upside: The grandparent retains control over the money in the 529. The downside: This approach can significantly impact the grandchild’s financial aid award.
Contributing to Someone Else’s 529
Once the money from a grandparent-owned 529 is used to pay for college costs, then what? The next time your grandchild fills out the FAFSA (the financial aid application that all students must file each year), they will have to report that money as income. The college will then reduce the amount of financial aid by approximately 25 percent.
For example, if a grandparent pays $5,000 from a 529 for a grandchild’s freshman year expenses, then sophomore year the school will likely reduce your grandchild’s financial aid by $1,250.
There is a way around this. Grandparents should hold off using the money in their 529 account until second semester of their grandchild’s junior year. “Use this money last,” suggests Gorrell. That’s because at that point your grandchild will have filed her final FAFSA.
Of course, if your grandchild won’t be eligible for any financial aid anyway because of their parents’ income bracket, then use the assets in a grandparent-owned 529 whenever you like.
A Grandchild’s Account
Contributing to a parent or grandchild’s account: The second way to save is for grandparents to simply contribute money to an already-established 529 plan. This includes a 529 owned by either the grandchild’s parents or the grandchild. You can send a check or use a portal like Ugift.com (if the 529 plan is a participant). The downside: The grandparent loses control over the money once they gift it to another 529 plan.
The upside: this approach has a minimal impact on financial aid because money will be viewed by the FAFSA as a parental asset (and assessed at just 5.64 percent). That same $5,000 would only reduce the grandchild’s financial aid by $250.
Note that a dependent student 529 is an exception to the rule that putting money in a student’s name should be avoided in advance of applying to college. That’s because student-owned 529 plans are counted as parental assets, not student assets, which are assessed at a higher rate.
A Lasting Legacy
Although the grandparent ultimately decides which way to go, it’s worth having a conversation so everyone can plan accordingly. “While surprises are usually great fun, this is one situation when surprises can backfire in a big way,” says Jack Shacht, founder of MyCollegePlanning.com. Grandparents may want to let their grandchild and his or her parents know their intent. In this way, funding can be coordinated together.
No matter how you coordinate the details, college contributions from grandparents are a valuable gift. Especially as “paying for college is the second largest expense most families will ever tackle, as tuition continues to increase at twice the rate of inflation,” notes Schacht. Even modest gifts reduce the long-term impact of college expenses.
“There are many things that can constitute fond memories of grandparents by grandchildren,” says Gorrell. “How wonderful for a grandchild headed to college to know that his grandmother or grandfather was part of this and made this possible.”
Diana Simeon is an editorial consultant for Your Teen.