Many grandparents want to leave an educational legacy by helping fund a grandchild's college education. Grandparents recognize the value of education, and want to see their children graduate without excessive student loan debt.
Here are 10 different ways a grandparent can help pay for college, and the pros and cons of each:
1. Pay tuition directly to your grandchild’s school
- 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.
- 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 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.
2. Offer your grandchild a loan
- 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.
- 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.
3. Pay off your grandchild’s student loans after they graduate
- 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.
- Your loan payments will be considered gifts, so any amount you give over $15,000 in one year will be subject to gift tax ($30,000 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.
4. Buy your grandchild U.S. Savings Bonds
- 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.
- 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.
5. Set up an education trust
- 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.
- 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.