Money Matters: Grandparents helping grandchildren with college costs

As everyone knows, a college education is expensive. To help, some grandparents may step in to assist with college costs. Doing this can be an effective way to pass assets to others without triggering gift or estate taxes.

Video Transcript

- Hello everyone, hope your summer is going well. You know it won't be too long before our kids get back to school, especially those college students. And a lot of grandparents asked me, well, how can I help my grandchildren with college expenses?

We know that college is expensive. And grandparents can certainly help by making some gifts, but you need to do it the right way. Under the current law, anyone can gift any individual up to $15,000 per year without having gift tax consequences. Now this amount is subject to inflation adjustments, it can change from year to year. The good news here is that tuition payments made directly to a college aren't considered taxable gifts. Note that this is in regards to tuition payments only, things like room, board, books, fees, other expenses can't be included. Those can be included under the $15,000 annual gift limitation.

Now these types of gifts will sometimes reduce the student's institutional financial aid, something to be concerned about for sure. So prior to sending a check, check things out. Make sure you're not doing damage to your kids and your grandchildren's for money that they might get for college.

Another option to dealing with college costs is grandparents making contributions to a section 529 plan with the grandchild as a beneficiary. Now these plans are designated to allow the funds to grow tax free, with withdrawals are also tax free if the funds are used to pay for qualified expenses. Qualified expenses may include tuition fees, room and board, and books and supplies, paid to any accredited school.

There are sometimes state level benefits too. One rule for 529 plans is the ability to make lump sum gifts up to five times the annual exclusion. That's right, you can do 15,000 times five years in advance or $75,000 right up front. Now you won't be able to make gifts in the next five years if you do that unless the exemption amount goes up.

So what happens if the grandchild doesn't attend college and you put all this money in a 529 plan? Well it can be withdrawn for other purposes, however the earnings in the plan would not be tax free, it would be taxable and there'd be a 10% penalty. Although as a grandparent maybe you have more than one grandchild, you can also change the beneficiary to another grandchild if they don't go to school and use the money there. Or even use it for yourself for a qualified training programs for some education for you.

Another caveat of 529s is the effect on financial aid. A 529 plan owned by grandparents does not need to be listed on the government's financial aid form when the money is withdrawn, it is counted as untaxed income at 50% by the FASFA. So that can hurt the grandchild's amount that they get for aid. If the parent owns the 529, that number 5.6%.

So parent owned 529 plan withdrawals don't count as income on the FASFA either. It should be noted that college might treat 529 plans differently than the government when it comes to financial aid. Now to avoid a negative impact on student aid when using money from a grandparent in a 529 plan, you may want to make the distributions in the latter couple of years. The reason for this is that the financial aid packages are based upon parents income a couple of years before someone goes to school.

So it might not have an effect on the aid, because the aid would have already been determined. One last option here is just get the child cash. Well again, that counts as income to the child can count against you. However, you can gift it to the parents and that works out a lot better.

Pretty simple, right? Well, not that simple. If you need help, check out your certified financial planner to get some help with this subject.