How Grandparents Can Help Bridge the College Cost Gap

If you’re a grandparent who would like to help fund your grandchild’s college education, here are some strategies.

529 college savings plan
This is one of the best vehicles for multigenerational college funding. 529 plans are offered by states and managed by financial institutions. Grandparents can open a 529 account of their own — either with their own state’s plan or another state’s plan — and name their grandchild as beneficiary (one grandchild per account), or they can contribute to an existing 529 account.

Once a 529 account it open, grandparents can contribute as much or as little as they want, subject to the individual plan’s lifetime limits, which are typically $300,000 and up. Grandparents can set up automatic monthly contributions or they can gift a larger lump sum.

Under rules unique to 529 plans, individuals can make a lump-sum gift of up to $70,000 ($140,000 for joint gifts by a married couple) and avoid federal gift tax by making a special election on their tax return to treat the gift as if it were made in equal installments over a five-year period. After five years, another lump-sum gift can be made.

What happens if a grandchild gets a scholarship?
Grandparents can seamlessly change the beneficiary of the 529 account to another grandchild, or they can make a penalty-free withdrawal from the account up to the amount of the scholarship.

Under current federal financial aid rules, a grandparent-owned 529 account is not counted as a parent or student asset, but withdrawals from a grandparent-owned 529 account are counted as student income in the following academic year, which can decrease the grandchild’s eligibility for financial aid in that year by up to 50%. Conversely, parent-owned 529 accounts are counted as parent assets up front, but withdrawals are not counted as student income — a more favorable treatment.

Outright cash gifts
To help reduce any potential gift tax implication, grandparents should keep their gift under the annual federal gift tax exclusion amount ($14,000 for individual gifts or $28,000 for joint gifts). A larger gift may be subject to federal gift tax and federal generation-skipping transfer tax.

An outright cash gift will be considered an asset for financial aid purposes. Under the federal aid formula, students must contribute 20% of their assets each year toward college costs, and parents must contribute 5.6% of their assets. 

Pay tuition directly to the college
Under federal law, tuition payments made directly to a college aren’t considered taxable gifts, no matter how large the payment. Only tuition qualifies for this federal gift tax exclusion; room and board aren’t eligible.

Aside from the benefit of being able to make larger tax-free gifts, paying tuition directly to the college ensures your money will be used for education purposes. However, the direct tuition payment might prompt a college to reduce any potential grant award in your grandchild’s financial aid package, so make sure to ask the college about the financial aid impact of your gift.

Prepared by Broadridge Investor Communication Solutions, Inc. Copyright 2016.

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