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COLLEGE SAVINGS 101

10 easy ways grandparents can help pay for college
http://www.savingforcollege.com/articles/10-easy-ways-grandparents-can-help-pay-for-college-801

Posted: 2015-07-08

by Kathryn Flynn

1. Pay tuition directly to your grandchild’s school

Pros:

  • Under a special tax-code exemption, the amount of tuition a grandparent pays the school will not be subject to gift tax.
  • It’s a simple way to pay for your grandchild’s college.
Cons:
  • There will be negative effects on the student’s financial aid eligibility:
    • Financial aid formulas may treat the direct payment as a dollar-for-dollar reduction in aid eligibility for the following year.
    • Or, the tuition payment will be treated as student income on the next year’s FAFSA, which will reduce aid eligibility by 50% of the amount paid (so a $10,000 tuition payment will reduce eligibility by $5,000).
  • The gift-tax exclusion only applies to tuition and does not include books, supplies and room and board.

How seven different assets can affect financial aid eligibility

2. Offer your grandchild a loan

Pros:

  • You can give an interest-free loan up to $10,000.
  • Loan amounts greater than $10,000 will be subject to a minimum IRS-set interest rate, but these rates are typically very low.
  • You can set the terms- for example, allow interest to accrue until graduation, require interest-only payments for a specified amount of time or eventually convert the loan to a gift.
Cons:
  • Interest on the loan will be taxable to you, but not deductible by your grandchild.
  • If you forgive the loan in your will your grandchild may end up owing income tax on the debt forgiveness.
  • Holidays may become awkward if your grandchild refuses to repay the loan.

A top college savings resource for grandparents

3. Pay off your grandchild’s student loans after they graduate

Pros:

  • There will be no effect on the grandchild’s financial aid eligibility.
  • Your grandchild will have an incentive to graduate.
  • He or she will be able to deduct student loan interest of up to $2,500 on their tax return without having to itemize.
Cons:
  • Your loan payments will be considered gifts, so any amount you give over $14,000 in one year will be subject to gift tax ($28,000 for married couples filing jointly). According to the College Board, that amount won’t even cover the current cost of one year of tuition, fees, and room and board at a public university.
  • Unforeseen circumstances (e.g. death, illness) before your grandchild graduates may prevent you from being able to keep your promise.

Seven things you may not know about student loan repayment

4. Buy your grandchild U.S. Savings Bonds

Pros:

  • U.S. Savings Bonds are easy to purchase at your local bank or from Treasurydirect.gov.
  • Savings bonds are a relatively safe investment that offer guaranteed interest if held to maturity.
  • Series EE and I bonds purchased after 1989 by someone age 24 or older may be redeemed tax-free when the proceeds are used to pay for higher education expenses.
Cons:
  • The tax exclusion on Series EE and I savings bonds doesn’t apply unless the grandchild is your dependent. That means you’ll have to pay income tax when the bonds are redeemed.
  • Interest rates have been at historic lows and are not keeping up with tuition inflation.
  • Individuals may only purchase $10,000 worth of each Series EE and Series I savings bonds per calendar year.

Are U.S. Savings Bonds still a good way to save for college?

5. Set up an education trust

Pros:

  • You are able to specify your wishes in the trust agreement, and the trustee will be legally obligated to fulfill them.
  • You’ll be able to restrict your grandchild’s access to the funds regardless of his or her age.
Cons:
  • Legal and accounting fees to establish and maintain a trust can be high.
  • Gifts are irrevocable, meaning that once you create the trust, you can’t undo it and get the funds back without the consent of the trustee and beneficiaries.
  • Any income earned in the trust will be taxed at high rates.

Can I claim higher education tax benefits for a non-dependent child?

6. Put money into a custodial account under UGMA/UTMA for your grandchild

Pros:

  • You can easily transfer cash, stocks and other types of property into this type of account.
  • Your grandchild’s first $1,000 of unearned income will be sheltered completely by the standard deduction, and the next $1,000 of unearned income will be taxed at their own tax bracket (10 percent for ordinary income and 0 percent for long-term capital gains).
Cons:
  • Your grandchild will assume all rights to the funds once he or she reaches legal age so there’s no guarantee that the money will be spent on college.
  • Any unearned income above $2,000 will trigger the “kiddie tax” and be taxed at the parents’ higher rate.
  • The value of a custodial account will be counted as a student asset on the FAFSA, and will reduce financial aid eligibility by 20% of the account value. So if the UGMA/UTMA account is worth $10,000, your grandchild’s aid eligibility will be reduced by $2,000.

Compare your savings options here

7. Contribute to a Coverdell Education Savings Account

Pros:

  • Earnings in the account will grow tax-free and will not be taxed at withdrawal when they are used to pay for K-12 or college expenses.
  • Coverdell ESAs allow you to self-direct your investments.
Cons:
  • You can only contribute up to $2,000 per grandchild each year. That won’t even cover a year at community college!
  • The child’s parent or guardian must be responsible for the account.
  • In order to use a Coverdell ESA, the child must be younger than 18 years old and the parents’ income must be below certain limits.

Coverdell ESA versus 529 plan

8. Open a 529 plan in your own name

Pros:

  • 529 accounts offer tax-free earnings and tax-free withdrawals when the money is spent on qualified higher education expenses, including tuition, books, supplies, and some room and board costs.
  • You can deposit up to $70,000 into a 529 plan without incurring gift taxes when you elect to treat the contribution as if it were made over a five-year period.
  • Your grandchild can use the funds from a 529 plan to pay for any eligible post-secondary institution.
  • Depending on where you live and which plan you open, you may get a state tax credit or deduction on your contributions.
Cons:
  • Although the money in the account will have no effect on your grandchild’s financial aid eligibility, the amount you withdraw to pay for his or her college will be counted as student income on the FASFA.
  • The earnings portion of non-qualified withdrawals are subject to income tax as well as a 10% penalty (there are special exceptions to the penalty when the beneficiary dies, becomes disabled, gets a scholarship or attends a U.S. Military Academy).
  • The money saved in your 529 account will be considered available assets that must be spent on medical and long-term care expenses before Medicaid can begin.

Before you open a grandparent-owned 529 account…

9. You can contribute to a 529 plan owned by your grandchild’s parent

Pros:

  • Your gift can grow substantially over time with tax-free earnings and tax-free withdrawals when the funds are used to pay for college.
  • There will be no effect on your grandchild’s FAFSA when the parent withdraws funds to pay for college.
  • You can still take advantage of the favorable gift-tax treatment on your contributions.
Cons:
  • Assets held in a student- or parent-owned 529 account will be counted as a parental asset on the FASFA, and can reduce aid eligibility by a maximum of 5.64% of the account value.
  • You will not have control of the funds since the account will be in the parent’s name.
  • You may or may not be able to claim a state tax credit or deduction on your contributions.

Eight reasons why grandparents love 529 plans

10. You can hire a financial planner to help your grandchild with planning for college

Pros:

  • You can rest easy knowing that your family is getting professional advice.
  • In addition to helping find the right investment vehicle for your gift, a financial planner can also help with finding scholarships, school and major selection and how to maximize your grandchild’s financial aid eligibility.
  • The family will be able to align their college savings with their retirement and other household investments.
Cons:
  • Some financial advisors can only offer investment products (including 529 plans) that are available through their broker-dealer firm.
  • There will be higher fees and expenses associated with an advisor-sold 529 plan.
  • You may not be involved in the decision-making process.

Is it a mistake not to hire a financial planner?

1. Pay tuition directly to your grandchild’s school

Pros:

  • Under a special tax-code exemption, the amount of tuition a grandparent pays the school will not be subject to gift tax.
  • It’s a simple way to pay for your grandchild’s college.
Cons:
  • There will be negative effects on the student’s financial aid eligibility:
    • Financial aid formulas may treat the direct payment as a dollar-for-dollar reduction in aid eligibility for the following year.
    • Or, the tuition payment will be treated as student income on the next year’s FAFSA, which will reduce aid eligibility by 50% of the amount paid (so a $10,000 tuition payment will reduce eligibility by $5,000).
  • The gift-tax exclusion only applies to tuition and does not include books, supplies and room and board.

How seven different assets can affect financial aid eligibility

2. Offer your grandchild a loan

Pros:

  • You can give an interest-free loan up to $10,000.
  • Loan amounts greater than $10,000 will be subject to a minimum IRS-set interest rate, but these rates are typically very low.
  • You can set the terms- for example, allow interest to accrue until graduation, require interest-only payments for a specified amount of time or eventually convert the loan to a gift.
Cons:
  • Interest on the loan will be taxable to you, but not deductible by your grandchild.
  • If you forgive the loan in your will your grandchild may end up owing income tax on the debt forgiveness.
  • Holidays may become awkward if your grandchild refuses to repay the loan.

A top college savings resource for grandparents

3. Pay off your grandchild’s student loans after they graduate

Pros:

  • There will be no effect on the grandchild’s financial aid eligibility.
  • Your grandchild will have an incentive to graduate.
  • He or she will be able to deduct student loan interest of up to $2,500 on their tax return without having to itemize.
Cons:
  • Your loan payments will be considered gifts, so any amount you give over $14,000 in one year will be subject to gift tax ($28,000 for married couples filing jointly). According to the College Board, that amount won’t even cover the current cost of one year of tuition, fees, and room and board at a public university.
  • Unforeseen circumstances (e.g. death, illness) before your grandchild graduates may prevent you from being able to keep your promise.

Seven things you may not know about student loan repayment

4. Buy your grandchild U.S. Savings Bonds

Pros:

  • U.S. Savings Bonds are easy to purchase at your local bank or from Treasurydirect.gov.
  • Savings bonds are a relatively safe investment that offer guaranteed interest if held to maturity.
  • Series EE and I bonds purchased after 1989 by someone age 24 or older may be redeemed tax-free when the proceeds are used to pay for higher education expenses.
Cons:
  • The tax exclusion on Series EE and I savings bonds doesn’t apply unless the grandchild is your dependent. That means you’ll have to pay income tax when the bonds are redeemed.
  • Interest rates have been at historic lows and are not keeping up with tuition inflation.
  • Individuals may only purchase $10,000 worth of each Series EE and Series I savings bonds per calendar year.

Are U.S. Savings Bonds still a good way to save for college?

5. Set up an education trust

Pros:

  • You are able to specify your wishes in the trust agreement, and the trustee will be legally obligated to fulfill them.
  • You’ll be able to restrict your grandchild’s access to the funds regardless of his or her age.
Cons:
  • Legal and accounting fees to establish and maintain a trust can be high.
  • Gifts are irrevocable, meaning that once you create the trust, you can’t undo it and get the funds back without the consent of the trustee and beneficiaries.
  • Any income earned in the trust will be taxed at high rates.

Can I claim higher education tax benefits for a non-dependent child?

6. Put money into a custodial account under UGMA/UTMA for your grandchild

Pros:

  • You can easily transfer cash, stocks and other types of property into this type of account.
  • Your grandchild’s first $1,000 of unearned income will be sheltered completely by the standard deduction, and the next $1,000 of unearned income will be taxed at their own tax bracket (10 percent for ordinary income and 0 percent for long-term capital gains).
Cons:
  • Your grandchild will assume all rights to the funds once he or she reaches legal age so there’s no guarantee that the money will be spent on college.
  • Any unearned income above $2,000 will trigger the “kiddie tax” and be taxed at the parents’ higher rate.
  • The value of a custodial account will be counted as a student asset on the FAFSA, and will reduce financial aid eligibility by 20% of the account value. So if the UGMA/UTMA account is worth $10,000, your grandchild’s aid eligibility will be reduced by $2,000.

Compare your savings options here

7. Contribute to a Coverdell Education Savings Account

Pros:

  • Earnings in the account will grow tax-free and will not be taxed at withdrawal when they are used to pay for K-12 or college expenses.
  • Coverdell ESAs allow you to self-direct your investments.
Cons:
  • You can only contribute up to $2,000 per grandchild each year. That won’t even cover a year at community college!
  • The child’s parent or guardian must be responsible for the account.
  • In order to use a Coverdell ESA, the child must be younger than 18 years old and the parents’ income must be below certain limits.

Coverdell ESA versus 529 plan

8. Open a 529 plan in your own name

Pros:

  • 529 accounts offer tax-free earnings and tax-free withdrawals when the money is spent on qualified higher education expenses, including tuition, books, supplies, and some room and board costs.
  • You can deposit up to $70,000 into a 529 plan without incurring gift taxes when you elect to treat the contribution as if it were made over a five-year period.
  • Your grandchild can use the funds from a 529 plan to pay for any eligible post-secondary institution.
  • Depending on where you live and which plan you open, you may get a state tax credit or deduction on your contributions.
Cons:
  • Although the money in the account will have no effect on your grandchild’s financial aid eligibility, the amount you withdraw to pay for his or her college will be counted as student income on the FASFA.
  • The earnings portion of non-qualified withdrawals are subject to income tax as well as a 10% penalty (there are special exceptions to the penalty when the beneficiary dies, becomes disabled, gets a scholarship or attends a U.S. Military Academy).
  • The money saved in your 529 account will be considered available assets that must be spent on medical and long-term care expenses before Medicaid can begin.

Before you open a grandparent-owned 529 account…

9. You can contribute to a 529 plan owned by your grandchild’s parent

Pros:

  • Your gift can grow substantially over time with tax-free earnings and tax-free withdrawals when the funds are used to pay for college.
  • There will be no effect on your grandchild’s FAFSA when the parent withdraws funds to pay for college.
  • You can still take advantage of the favorable gift-tax treatment on your contributions.
Cons:
  • Assets held in a student- or parent-owned 529 account will be counted as a parental asset on the FASFA, and can reduce aid eligibility by a maximum of 5.64% of the account value.
  • You will not have control of the funds since the account will be in the parent’s name.
  • You may or may not be able to claim a state tax credit or deduction on your contributions.

Eight reasons why grandparents love 529 plans

10. You can hire a financial planner to help your grandchild with planning for college

Pros:

  • You can rest easy knowing that your family is getting professional advice.
  • In addition to helping find the right investment vehicle for your gift, a financial planner can also help with finding scholarships, school and major selection and how to maximize your grandchild’s financial aid eligibility.
  • The family will be able to align their college savings with their retirement and other household investments.
Cons:
  • Some financial advisors can only offer investment products (including 529 plans) that are available through their broker-dealer firm.
  • There will be higher fees and expenses associated with an advisor-sold 529 plan.
  • You may not be involved in the decision-making process.

Is it a mistake not to hire a financial planner?

 

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