By Peter C. Golotko, CPA/PFS, MBA and Leighann Davis, Portfolio Analyst
Helping a grandchild pay for college not only helps the grandchild, but it can also be a smart way to pass on wealth without having to pay gift and estate taxes. Below, we outline a few strategies that a grandparent can use to help grandchildren with college costs:
Gifting Cash to Grandchild
Writing a check to the child is the easiest and most straightforward option. However, there are a few drawbacks to giving cash. Grandparents may gift $14,000 for individual gifts and $28,000 for gifts made by a married couple without tax consequences. Gifting over that annual federal gift tax exclusion amount might result in gift tax and generation-skipping transfer tax consequences. A cash gift to a student is also considered untaxed income by the federal government’s aid application (FAFSA). Under the FASFA, student income is assessed at a higher rate than parental income, which can adversely affect financial aid eligibility.
Gifting Cash to the Parents of the Child
As an alternative, grandparents can choose to give the cash gift to the child’s parent instead of the grandchild. The same annual gift exclusion amounts would apply, but it would not be reported as income in the child’s name so funds would be assessed at a lower rate when determining financial aid eligibility.
Gifting Cash to Child After Graduation
Grandparents may also wait until the student graduates from college to gift the grandchild with cash to pay toward student loans. By waiting until after graduation, the cash gift does not affect the financial aid eligibility of the child, allowing the child to potentially receive greater financial aid and resulting in a smaller student loan balance.
Pay Tuition Directly to The College
Tuition payments made directly to a college are not considered taxable gifts and have no limit as to the amount of the payment. The advantages with this option is the avoidance of gift tax, the assurance that the funds are going to their intended purpose, and the removal of the money from the grandparent’s estate. However, payments can only be made for tuition. Room and board, books, fees, equipment, and other similar expenses do not qualify and would have to be paid for by other means (a separate tax-free gift up to $14,000/$28,000 for joint, for example). The drawback of this option is that colleges will often reduce a student’s aid by the amount of the grandparent’s payment. Inquire as to how your payment will affect the child’s financial aid. If it will affect it adversely, consider waiting until the child graduates to gift cash that the child can use toward student loans.
College Savings Plans
One of the more popular methods for assisting grandchildren with college is through a variety of savings plans and accounts, including 529 College Savings Plans, Prepaid Plans, Coverdell Education Savings Accounts, and UTMA/UGMA accounts. These accounts allow grandparents to begin saving for their grandchildren years in advance, and offer varying tax and other benefits.
Which option is the best will depend on each individual or couple’s personal circumstances and goals. Before making a decision, request additional information from a trusted financial planner to see how each method will affect you and your grandchild. In the next article, we will detail the differences in each of the above-mentioned college savings plans and the pros and cons of each.
Peter C. Golotko, CPA/PFS, MBA is President and CEO of CPS Investment Advisors. Leighann Davis, Portfolio Analyst, is a contributing author of this article.