How Grandparents Can Help Grandchildren With College Costs

With the cost of attending college soaring today, students are depending more and more on their families for financial aid. Government financial aid programs of the past are decreasing, while cash-starved state governments are increasing tuition and fees at public universities across the nation. Even government-backed student loans are harder to obtain.

As the cost of a college education continues to climb, many grandparents are stepping in to help. This trend is expected to accelerate as baby boomers become grandparents and start gifting what's predicted to be trillions of dollars over the coming decades.

A college education is one of the best gifts a grandparent can give a grandchild. But it’s important to carefully consider your options before proceeding.

Outright Cash Gifts

A common way for grandparents to help grandchildren with college costs is to make an outright gift of cash or securities. But this method has a couple of drawbacks. A gift of more than the annual federal gift tax exclusion amount ($13,000 for individual gifts and $26,000 for gifts made by a married couple) might have gift tax and generation-skipping transfer (GST) tax consequences (GST tax is an additional gift tax imposed on gifts made to someone who is more than one generation below you). Another drawback is that a cash gift to a student will be considered untaxed income by the federal government's aid application (the FAFSA) and student income is assessed at a rate of 50%, which can impact financial aid eligibility.

I feel the best option is to pay the college directly (see below).  One workaround is for the grandparent to give the cash gift to the parent instead of the grandchild, because gifts to parents do not need to be reported as income on the FAFSA. Another solution is to wait until your grandchild graduates college and then give a cash gift that can be used to pay off school loans.

Pay Tuition Directly to the College

Under federal law, tuition payments made directly to a college are not considered taxable gifts, no matter how large the payment. So grandparents don't have to worry about the $13,000 annual federal gift tax exclusion. But payments can only be made for tuition - room and board, books, fees, equipment, and other similar expenses don't qualify. Aside from the obvious tax advantage, paying tuition directly to the college ensures that your money will be used for the education purpose you intended, plus it removes the money from your estate. And you are still free to give your grandchild a separate tax-free gift each year up to the $13,000 limit ($26,000 for joint gifts).

However, colleges will often reduce a student's institutional financial aid by the amount of the grandparent's payment. So before sending a check, ask the college how it will affect your grandchild's eligibility for college-based aid. If your contribution will adversely affect your grandchild's aid package, particularly the scholarship or grant portion, consider gifting the money to your grandchild after graduation to help him or her pay off student loans.

529 plans

A 529 plan can be an excellent way for grandparents to contribute to a grandchild's college education, while simultaneously paring down their own estate. Contributions to a 529 plan grow tax deferred, and withdrawals used for the beneficiary's qualified education expenses are completely tax free at the federal level, and generally at the state level too.

There are two types of 529 plans: college savings plans and prepaid tuition plans. College savings plans are individual investment-type accounts offered by nearly all states and managed by financial institutions.  Funds can be used at any accredited college in the United States or abroad. Prepaid tuition plans allow prepayment of tuition at today's prices for the limited group of colleges, typically in-state public colleges, that participate in the plan.

Grandparents can open a 529 account and name a grandchild as beneficiary (only one person can be listed as account owner) or they can contribute to an already existing 529 account. Grandparents can contribute a lump sum to a grandchild's 529 account, or they can contribute smaller, regular amounts.

Investors should consider the investment objectives, risks, charges, and expenses associated with 529 plans before investing. Contact a Certified Financial Planner to discuss your options for helping to pay for your grandchildren’s education. 

Adam Obrecht, CFP® is the owner and founder of AO Wealth Advisory in Waukee, Iowa.  His life passion is helping individuals, families and businesses maximize what they earn, invest wisely, and give generously to their family, charities, and community.  Adam is on Facebook and Linked-In.

Securities offered through Broker Dealer Financial Services Corp., Member FINRA & SIPC.  Advisory services offered through Investment Advisors Corp., an SEC registered investment adviser.