What is the best way for grandparents to pay for college?
What is the best way for grandparents to pay for college?
I work with many children from wealthy families whose parents are still alive.
I hear the same question from ALL my clients with kids: how are we going to pay for college?
I always have the same response: have you talked to your parents?
The answer is almost always no.
I’m on a mission to change that.
Keep reading for everything you need to know about supporting grandkids’ future and education, whether you’re a parent opening discussions on behalf of your kids, or a grandparent trying to understand your giving options.
Posted on June 27, 2024 by Katherine Fox.
What is the best way for grandparents to pay for college?
Most people don’t have any idea where to start when it comes to grandparents paying for college.
You might be wondering:
How can I ask my parents/my kids' grandparents for money for college?
Should I set up a college fund for my grandchild?
What is the best way to give money to grandchildren for education?
What are the tax consequences of giving money to grandchildren?
What is “superfunding” a 529 plan?
Are gifts to grandchildren tax deductible?
Can grandparents open a 529 for grandchildren?
What are the disadvantages of grandparent-owned 529 plans?
I’m Katherine. I’m a CFP® and financial advisor for inheritance.
I’m here to help you through this journey, whatever your needs are.
If you’re trying to get up to speed, check out the 20 Terms Inheritors Need to Know.
And if you’re deep in the weeds and don’t know what to do next, schedule a FREE consultation to see how I can help you build a plan discuss funding education for your kids or grandkids.
How can I ask grandparents to help with my kids’ college?
It’s not as hard as you think.
Try:
“Have you thought about if you would like to support [insert your children’s names] college education”
Or,
“I set up 529 plans for [insert your children’s names] to help save for college. Would you be interested in learning how to contribute?”
It doesn’t need to be any more complicated than that.
If wealthy families provide any support to their children or grandchildren, the first and most common place is through education funding.
An emphasis on education is an extremely important value and the cost of college, as well as the impact of student debt, is well known.
Be open that your parents may need educating about the cost of college:
Say you have a child who will start college in 2039
The annual cost of attendance at a 4-year private university (e.g., Stanford) is over $80,000 for the 2024-2025 school year.
This cost has been increasing by an average of 3.5%/year over the past decade.
If this increase continues, 4 years at Stanford could cost over $536,000 in 2039.
If your parents are at all inclined to support your children’s higher education, showing them these numbers should help their decision.
What is the best way for grandparents to pay for college?
I’ve heard from grandparents that are unsure if they should help their children by contributing to their grandchildren’s higher education expenses. My answer is ALWAYS that if they can, they should.
Should I set up a college fund for my grandchild?
Yes! Did you see those numbers up there?
College is insanely expensive. Giving your grandchildren access to a debt-free education is a fantastic way to set them up for future financial and life success.
However, you might not want to set up a college fund (known as a 529 plan) for them yourself. There are several intricacies of 529 plans that generally make it preferred for parents to own the plans with their children as beneficiaries.
Keep reading to understand why that is and learn the best ways that you can fund your grandchildren’s higher education, whether they end up at a 4-year college, community college, or trade school.
What is the best way to give money to grandchildren for education?
There are three primary ways to give money to grandchildren for their education:
529 plans
UTMA accounts
Paying tuition directly to the school
What is a 529 plan?
529 plans are tax-preferences, state-sponsored education savings accounts.
Cash is contributed to these accounts, invested in the stock market, and can be withdrawn tax-free to pay for qualified educational expenses.
Qualified expenses include tuition, room and board, supplies, books, et cetera at any type of higher education institution (4 year college, 2 year college, community college, trade school et cetera).
There are four key benefits of a 529 plan:
Tax Advantages: Contributions to a 529 plan grow tax-deferred, and withdrawals for qualified education expenses are tax-free. Some states also offer tax deductions or credits for contributions to their state's 529 plan.
Flexibility: Funds in a 529 plan can be used to pay for tuition at a 4 year college, 2 year college, community college, or trade school. In addition to tuition, money from a 529 plan can be used to pay for room and board, books, and other educational supplies.
Control: The 529 account owner retains control over assets in a 529 plan, regardless of the beneficiary’s age. If a beneficiary does not attend college or has money left over in a 529 plan, the 529 account owner can also change the designated beneficiary to another lineal relative of the initial plan beneficiary.
Low Impact on Financial Aid: Under the FAFSA, 529 plan assets owned by parents or students are considered parental assets and have a lower impact on student aid calculations.
529 plans offer a significant tax benefit for college saving, but they also restrict money for that purpose. Funds withdrawn from a 529 plan NOT used to pay for qualified educational expenses are subject to income tax AND a 10% penalty.
What is an UTMA account?
UTMA accounts are custodial investment accounts for minors.
Cash or assets are put in the name of an UTMA account, which is managed by a custodian on behalf of a minor child.
Money can be withdrawn from an UTMA account for the direct benefit of the beneficiary, including to pay for educational expenses.
When the child beneficiary reaches the age of majority (between 18 and 25 depending on the state) the UTMA transfers to their name and they gain full control over the account.
UTMA accounts offer a greater degree of flexibility than 529 accounts, but they do not come with any tax benefits and they do not restrict funds after the beneficiary has reached young adulthood.
Additionally, most income and capital gains from an UTMA account will increase a family’s taxable income.
The IRS imposes a “Kiddie Tax” in which the first $1,300 of a child’s unearned income is free from tax. The next $1,300 of unearned income is taxed at the child’s marginal tax rate. Any unearned income above $2,600 attributable to the child is taxed at the parent’s marginal tax rate.
Can grandparents pay college tuition directly?
Yes! This is a common strategy.
The primary benefit is that payment of college tuition (tuition only, NOT other related educational expenses like room and board) made directly to a college or university does not count as a gift to the individual student.
Grandparents who have sufficient cash flow may choose to make a promise to pay a grandchild’s tuition directly. This allows them to remove money from their taxable estate annually without decreasing their lifetime gift exemption limit.
Grandparents using this strategy may choose to contribute a smaller amount to a 529 account when their grandchild is young to cover room and board and other non-tuition expenses. Then, when their grandchild goes to school they pay tuition directly from their own wealth.
This strategy also reduces the possibility and likelihood of overfunding a 529 account.
“If wealthy families provide any support to their children or grandchildren, the first and most common place is through education funding.
An emphasis on education is an extremely important value and the cost of college, as well as the impact of student debt, is well known. ”
What are the tax consequences of giving money to grandchildren?
In 2024, any individual can make gifts of $18,000 to another individual without having to report anything to the IRS.
Any married couple can also elect to “split gifts” and give $36,000 to another individual without having to report anything to the IRS.
When it comes to college funding, many grandparents want to make larger gifts when their grandchildren are young, to allow time for compound interest to work in their family’s favor.
It is a common misconception that gifts over the IRS annual gift exemption limit create an immediate tax consequence.
Gifts over $18,000 (single giver) / $36,000 (married couple) must be reported to the IRS, but they do not create any immediate tax liability.
Instead, the total of these above-exemption gifts over the course of a person’s lifetime serves to decrease their overall estate tax exemption at death.
The current estate tax exemption is $13.61 million for an individual and $27.22 million for a married couple.
Use the following example:
A married couple decided to give $250,000 to their grandchild in an UTMA account to provide for their future needs and educational expenses.
The elect to split gifts, meaning that $36,000 of their gift is non-reportable to the IRS.
The remaining $214,000 is required to be reported to the IRS on Form 709. This $214,000 will not create any immediate tax consequences for the couple.
However, their combined estate tax exemption will be reduced from $27.22 million to $21.08 million.
The couples total net worth is only $12 million, so they don’t expect to realize any tax consequences from the gift they made to their grandchild.
What is “Superfunding” a 529 plan?
529 plans offer a unique provision for wealthy families who want to put a large amount of money in the account when their grandchildren are young and allow it time to grow.
Colloquially called “superfunding” it creates an opportunity to make five years of gifts at once into a 529 plan.
Use the following example:
A married couple decides to “Superfund” their grandchild’s 529 account.
They make an $180,000 contribution ($36,000/year x 5 years) to her 529 plan in Year 1.
They have to report that “superfund” on IRS Form 709, but it does not count against their combined estate tax exemption
However, ANY gifts this couple makes to their grandchild in the following 5 years WILL count against their combined estate tax exemption and reduce their exemption by the
amount of the gift made.
“Superfunding” a 529 plan can also be considered as “forward-funding.” You make five years of gifts in year one, using up your gift exemption for that individual for the next five years.
Are gifts to grandchildren tax deductible?
Gifts made directly to grandchildren are generally not tax deductible.
However, some states do have tax deductions for 529 contributions. These contributions are ONLY available if you are contributing into a 529 account that you also loan.
These tax deductions are generally small and phase out at relatively low income levels.
Can grandparents open a 529 for grandchildren?
Yes, grandparents can open a 529 plan for their grandchildren.
The easiest way to open a 529 plan is to google “[your state] 529 plan.” You should be able to easily set up an account, or have your child set up an account for you.
The one area to note with 529 plans is underlying fees.
States vary greatly with regards to how much they charge to administer 529 plans as well as the cost of the underlying investments.
If you are willing to forgo the tax deduction and/or live in a state with high fees, Utah is often cited as the low-cost 529 plan of choice.
There are, however, several disadvantages to grandparents owning 529 plans.
What are the disadvantages of grandparent-owned 529 plans?
The primary disadvantage of grandparent-owned 529 plans is the impact on grandchildren’s financial aid. While many wealthy families expect to fully fund college for their grandchildren, this is still an important area to understand.
The FAFSA financial aid form does not consider distributions from a student or parent-owned 529 plan as income.
However, distributions from grandparent owned 529 plans are treated as untaxed student income under the FAFSA’s calculations. This income can reduce the amount of financial aid a student is eligible for by up to 50% of the distribution amount.
The FAFSA has a two-year income lookback period, so a student who used a grandparent-owned 529 to pay for college for their Freshman year would not see an impact on their financial aid until their Junior year.
A secondary disadvantage is that having multiple 529 accounts increases parental complexity and the amount of mental energy needed to plan for college funding.
This is the primary reason that I don’t encourage grandparents to own 529 plans for their grandchildren, but instead contribute money into 529 plans their children have set up.
It is difficult to remember and track money across various accounts, and planning and preparing for college is a stressful period.
Giving parents full transparency and control over the assets available to fund their children’s education can increase agency and reduce stress and friction in your relationship.
Let’s take the next step together
Understanding how to manage an inheritance held in a trust fund is not easy. Inheritors can encounter a wide variety of different situations requiring knowledge and finesse to manage. If you need more help, you can download The 20 Inheritance Terms You Need to Know, or reach out to Katherine Fox, CFP® and CAP®, a fiduciary, fee-only financial planner to learn how Sunnybranch can help you build a plan to manage your inheritance held in a trust fund.
