Many grandparents would like to help their grandchildren with the steep costs of higher education. That’s often a laudable goal, but some methods of providing this assistance might be more effective than other tactics.
The simplest tactic is to give money to youngsters before or during their college years. In 2015, the annual gift tax exclusion was $14,000 per recipient.
Example 1: Cora Smith has three grandchildren. She can give each of them $14,000 this year for their college funds. Cora’s husband, Rob, can make identical gifts to each of their grandchildren. Such gifts will have no adverse tax consequences. (Larger gifts may reduce this couple’s gift tax exemption and, ultimately, their estate tax exemption.)
In addition to all of these $14,000 gifts, the Smiths can pay the college tuition for any of their grandchildren. No matter how large these outlays might be, Cora and Rob will not owe any tax or suffer any reduction in their transfer tax breaks.
Such grandparent gifts may have their disadvantages, though. They could result in reduced financial aid.
Example 2: Over the years, Rob and Cora have made gifts to their grandson Doug. Counting investment buildup, Doug has $50,000 worth of assets when he fills out the Free Application for Federal Student Aid (FAFSA) for his first year of college. The FAFSA assesses Doug’s assets by 20%, when calculating the expected family contribution (EFC), so the $50,000 could reduce his financial aid by $10,000: the 20% assessment times $50,000 of Doug’s assets. Tuition payments by Rob and Cora for Doug’s schooling could result in even larger aid cutbacks.
For some grandparents, this won’t be a major concern. The student’s immediate family might have such extensive assets and such substantial income that need-based financial aid won’t be possible. However, today’s college costs are so high that aid might be available, even to well-off families. The possible impact on financial aid should be discussed with the student’s parents.
In addition, it should be considered that assets given to grandchildren will come under the youngsters’ control once they come of age, usually on or before age 21. Grandparents need to be comfortable with the idea that money in a grandchild’s account may or may not be used for education or other worthwhile purposes.
Grandparents to parents
Instead of making gifts directly to grandchildren, grandparents can give assets to their own children who are the student’s parents. This plan will have less impact on financial aid.
Example 3: Assume that Cora and Rob have made gifts to their daughter Elly, Doug’s mother, rather than making gifts directly to Doug. Such gifts have increased Elly’s assets by $50,000. A parent’s assets are assessed at no more than 5.64%, on the FAFSA, so the additional assets held in Elly’s name would reduce possible aid by $2,820: 5.64% of $50,000.
Therefore, giving money to the student’s parent would be better than giving money to the student, if financial aid is a concern, and, assuming the parents are more financially prudent, less chance exists of the transferred assets being squandered.
Focusing on 529 plans
If concerns about the security and intent of the gifted funds still exist, they may be addressed by contributing to a 529 college savings plan, instead. Such plans have many advantages.
Example 4: Cora Smith creates three 529 accounts, naming a different grandchild as the beneficiary for each one. Now Cora has control over how the money will be invested and how it will be spent. Any investment earnings will be tax-free and distributions also will be untaxed if the money is used for the beneficiary’s college bills. Cora can even reclaim the funds in the 529 if she needs money, paying tax and (with some exceptions) a 10% penalty on any earnings.
What’s more, a 529 account owned by a grandparent won’t be reported on the grandchild’s FAFSA, so it will not have any initial impact on financial aid. It’s true that eventual distributions from a grandparent’s 529 will be reported on a subsequent FAFSA and will substantially reduce financial aid. That won’t be a concern for families who are not receiving need-based aid. If the student is receiving aid, distributions from the grandparent’s 529 plan can be postponed until the last FAFSA has been filed.
Example 5: Doug Franklin will start college in the 2015-2016 school year, so he files his first FAFSA in January 2015. Doug receives some need-based aid, so his grandmother Cora lets the 529 account continue to grow, untaxed. Doug files a new FAFSA every year until January 2018, when he submits the form for his senior year. Subsequently, Cora can tap the 529 account to pay Doug’s remaining college bills. Doug won’t be filing any more FAFSAs for financial aid, so Cora’s 529 distributions won’t be reported. The bottom line is that grandparents have many tactics they can consider if they wish to give grandchildren a financial assist on the path towards a college degree.