Funding college for your grandchild
In addition to thinking about your retirement needs, we find that it is common for grandparents to want to help fund their grandchildren’s college education as well. If possible financially, helping to fund your grandchild’s college offers a great way to invest in your grandchild’s future and help them with the ever-growing costs of a college education. However, before doing so there are some things that you must consider to avoid the possible mistakes that can come with this funding process.
What to consider first? Yourself! Most important to deciding how you will help assist your grandchild in their education is deciding how much you can contribute while keeping your own financial goals intact. It is critical to have this discussion with a Certified Financial Planner® to make sure your contributions to funding your grandchild’s education will not compromise your overall financial plan.
Once this has been established, there are a couple of different routes to take to help fund your grandchild’s education. One option is through a UTMA / UGMA. These accounts known as Uniform Transfer / Gift to Minors Act accounts provide a way to avoid tax consequences for a minor until they become legal age (18 or 21 years old).
These accounts work for children to avoid some tax burden on smaller gifts, however there is a significant downside to consider with using these accounts to fund college due to their negative impact on financial aid. These accounts are considered as a student asset on the FAFSA, and therefore are counted as 20% of the value of the asset on the FAFSA instead of a maximum of 5.29% for traditional parent owned assets[1].
Instead of funding through an UTMA / UGMA, a more common approach is to use a grandparent owned 529 plan. 529 plans allow for partially tax deductible contributions (Up to $2,000 if married filing jointly in Massachusetts) as well as contributions that grow tax deferred and tax free withdrawals.
Another option that operates similarly to a 529 plan is a Coverdell education savings account. These accounts offer the similar tax advantages as a 529 plan with money growing tax deferred and tax free withdrawals. However, the major difference is in the contribution limits. A Coverdell education savings account has a maximum contribution amount of only $2,000 annually[2], while 529 plans have essentially no annual maximum. For this reason, 529 plans are the most popular choice.
The balance of a grandparent-owned 529 plan is not counted on the FAFSA, and won’t hurt the eligibility for your grandchild to receive need-based financial aid. However, distributions from the grandparent owned 529 plan can decrease financial aid eligibility for the student by up to 50%[3] as distributions are counted as income to the student for that year.
For example, a student that was to receive $30,000 in financial aid from the school may only receive $15,000 from the school if they withdraw $30,000 from the grandparent owned 529 to pay the tuition bill.
This may not sound great, but there is a strategy to get around this. The FAFSA used for the current year is based on income from two years prior. Because of this, the “income to the student” from withdrawing from the grandparent 529 plan will only hurt the student’s financial aid eligibility for their junior and senior year of college.
However, if your grandchild waits to take money from the grandparent owned 529 plan until paying for their junior and senior year of college, there will not be an impact on their financial aid. This comes as a result of the 2 year delay in how income is treated on the FAFSA.
Now that you know what accounts to use, it is important to know how much to contribute. As of 2019 federal tax law, the annual gift tax exemption is $15,000 per year[4] per individual ($30,000 per couple). This allows for annual contributions to the 529 plan up to $15,000 ($30,000 per couple) without making it a taxable gift.
Helping to fund your grandchild’s college education is a rewarding activity but it can also be a complicated process. We encourage you to give us a call if you have questions on the topic. We are here to help.
All the best,
Andrew Holmes
617-630-4978
Financial Planning Solutions, LLC (FPS) is a Registered Investment Advisor. Financial Planning Solutions, LLC (FPS) provides this blog for informational and educational purposes only. Nothing in this blog should be considered investment, tax, or legal advice. FPS only renders personalized advice to each client. Information herein includes opinions and source information that is believed to be reliable. However, such information may not be independently verified by FPS. Please see important disclosures link at the bottom of this page.
[1] Hurley, Joseph. “Should You Open an Ugma/Utma 529?” Savingforcollege.com, 2008
[2] Schwab.com. “Saving for College: Coverdell Education Savings Accounts.” Schwab Brokerage, 9 May 2019
[3] Kitces, Michael. “Grandparent 529 Plans Other College Funding Tactics.” Nerd's Eye View | Kitces.com, 1 Feb. 2019
[4] “Frequently Asked Questions on Gift Taxes.” Internal Revenue Service