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 grandchildren graduate without excessive student loan debt.
But it can be difficult to determine the best way to help grandchildren pay for college, and what forms of help your children and grandchildren would appreciate the most.
Wealth advisor Jack Wang of Innovative Advisory Group says grandparents should take a proactive approach and raise the subject well in advance, so parents have a clear understanding of their savings goals and how much help you can provide.
“Grandparents can encourage parents and students to plan early and to really look at how much colleges cost after any potential aid,” he says. “The major mistake that many families make is to find the school first — typically without regard to cost, and then hope they get enough aid to make the school affordable.”
With accurate numbers in mind and realistic goals, families can choose the best course of action. Here are 13 different ways grandparents can help pay for college:
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. If you choose this method, remember that the gift-tax exclusion only applies to tuition and does not include books, supplies and room and board. It’s a simple way to pay for your grandchild’s college.
2. Open a 529 plan in your own name
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 $80,000 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 for your contributions.
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, receives educational assistance through a qualifying employer program or attends a U.S. Military Academy). In some states, 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.
3. You can contribute to a 529 plan owned by your grandchild’s parent
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.
Assets held in a student- or parent-owned 529 account will be counted as a parental asset on the FAFSA, 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.
4. Offer your grandchild a loan
You can give an interest-free loan of 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.
One of the advantages of this method is you get to set the terms. For example, you could allow interest to accrue until graduation, require interest-only payments for a specified amount of time, or eventually convert the loan to a gift.
When setting the terms, keep in mind interest on the loan will be taxable to you, but not deductible by your grandchild. And if you forgive the loan in your will, your grandchild may end up owing income tax on the debt forgiveness. Above all, be aware that loaning money always carries some risk—holidays could become awkward if your grandchild refuses to repay the loan.
5. Pay off your grandchild’s student loans after they graduate
If you choose to help in this way, it will have no effect on the grandchild’s financial aid eligibility, and your grandchild will have an incentive to graduate. He or she will also be able to deduct student loan interest of up to $2,500 on their tax return without having to itemize.
But one potential drawback to note: 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. And unforeseen circumstances, such as death or illness, before your grandchild graduates may prevent you from being able to keep your promise.
6. Support and encourage your grandchildren’s interests
Money isn’t the only way to support your grandchildren’s education. Showing interest in their passions can also be a powerful way to help. For example, asking about a school project they loved, attending their performances, or cheering from the sidelines can provide a big emotional boost. And offering practical support, such as rides to sports practices or music lessons, can help them pursue activities that instill important skills and make them competitive college applicants.
7. Buy your grandchild U.S. Savings Bonds
U.S. Savings Bonds are easy to purchase at your local bank or from Treasurydirect.gov, and they 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.
But be aware 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. Individuals may only purchase $10,000 worth of each Series EE and Series I savings bonds per calendar year.
8. Set up an education trust
Trusts provide a measure of control because you can specify your wishes in the trust agreement, and the trustee will be legally obligated to fulfill them. You can also restrict your grandchild’s access to the funds regardless of his or her age.
But legal and accounting fees to establish and maintain a trust can be high. And 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.
9. Assist in the college savings and college search efforts
Stepping in with practical help can go a long way toward taking some of the pressure off busy parents and students. Are your kids just beginning to plot out their college savings plan? Volunteer to watch your grandchildren for the evening and give their parents time to research and create their savings strategy. Or ask if you can help with the research by gathering information on 529 plans, or looking into future college costs for them.
If your grandchild is in high school and starting to think about colleges they might be interested in, you might offer to visit colleges with them — or babysit their siblings while your child and grandchild attend campus tours.
10. Put money into a custodial account under UGMA/UTMA for your grandchild
You can easily transfer cash, stocks and other types of property into this type of account. Your grandchild’s first $1,250 of unearned income will be sheltered completely by the standard deduction, and the next $1,250 of unearned income will be taxed at their own tax bracket (10% for ordinary income and 0% for long-term capital gains).
With this type of account, 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 $2,500 will trigger the “Kiddie Tax” and be taxed at the rates that apply to trusts and estates.
11. Contribute to a Coverdell Education Savings Account
Earnings in Coverdell ESAs will grow tax-free and will not be taxed at withdrawal when they are used to pay for qualified K-12 and college expenses, and they allow you to self-direct your investments.
But there are some limitations: You can only contribute up to $2,000 per grandchild per year. The child’s parent or guardian must be responsible for the account. And 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.
12. Share the gift of your time and interests
Your relationship with your grandchild and the ideas and experiences you expose them to are powerful in and of themselves. You never know how your presence might influence their future endeavors.
“Grandparents can be a major factor for the student in social, cultural, or academic aspects,” Wang says.
Visiting museums with your grandchild might inspire an interest in art or history. Going on hikes together could lead to their interest in environmental conservation. Spending time together in the kitchen, the garden, or even sharing stories from your childhood can all provide valuable lessons for young learners that pay dividends later on.
13. You can hire a financial planner to help your grandchild with planning for college
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 may 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.
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.
The Bottom Line
Grandparents can play a vital role in helping grandchildren prepare for college. From contributing to college funds to being an active member of their fan club, every effort you make has the potential to make a lasting impact.