You probably remember when it was possible to pay for college with the money you earned from part-time and summer jobs. Now, unless your grandchildren develop the next Facebook or Snapchat, those places of summer employment are simply not going to be good enough.
Over the past four decades, college tuition has increased at double the inflation rate, putting a strain on family finances and throwing millions of teenagers into student loans and, consequently, student debt. While many grandparents are eager to help, it’s slightly more complicated than just mailing them a check on the day your grandchild turns 18 years old. Any monetary gifts you give to your grandkids may have tax implications for you, either beneficial or detrimental, and if your grandkids apply for financial aid or tuition assistance, your well-meaning generosity could backfire. Here are five effective ways that you can help your grandkids with college:
1. Pay the Bill Yourself
One way to avoid taxes is to directly pay your grandkids’ tuition. Even if the amount you plan to pay is more than the yearly limit, you don’t have to file a gift tax return since these payments, or gifts, aren’t considered taxable. However, you must make the tuition payment directly to the school, not the grandchild or the parents, and the exemption is only valid for the cost of tuition. Payments for room, board and other costs are subject to gift tax limits. It’s important to note that direct gifts will eliminate or reduce your grandchild’s need-based financial aid eligibility, so only consider this option if you’re positive that your grandchild won’t qualify, or wait until he or she files the last FAFSA to make the payment.
2. Invest in a 529 Savings Plan
529 savings plans are sponsored by the District of Columbia and 48 states and provide a tax-efficient way for you to help with college costs. Withdrawals aren’t taxed as long as the money is used for qualified expenses such as room and board, fees, and tuition, and you are not responsible for paying taxes on the growth of the earnings. In addition, you could get a tax break on your contributions depending on the state in which you take out the 529 plan, and you are entitled to invest in any state plan that you choose, regardless of whether you reside in that state.
3. Contribute to a Coverdell
Similar to 529 savings plans, money invested in a Coverdell education savings account grows tax-deferred, and you aren’t subject to tax on any withdrawals so long as your grandchild uses the money for qualified expenses for his or her education. You also have more investment choices since you can establish a Coverdell account at a brokerage firm or bank. However, keep in mind that the maximum contribution limit of $2,000 a year is lower than a 529 plan, and your modified adjusted gross income is no more than $220,000 if you’re married and file jointly or $110,000 if you’re single. In addition, since you aren’t able to use the money yourself or transfer it to another grandchild or beneficiary, you don’t have quite the same amount of control over a Coverdell account compared to a 529 plan.
4. Set Up a Custodial Account
Custodial accounts allow you to put your money or other assets into a trust for a minor child. Since you are the trustee, you are responsible for managing and handling the account until your grandchild turns 18 or 21, depending on the state. However, once your grandchild is of age, he or she can use the money for any purchase or for any reason that he or she deems necessary. Also, since the custodial account is considered to be your grandchild’s asset and not yours, he or she risks eligibility for financial aid.
5. Pay Off Student Loans
If you’re looking to get a lower interest rate for your grandchild, cosigning a private student loan can do the trick. However, you’re responsible for the payments and/or remaining balance if your grandchild falls behind or defaults on the loan. Debt collectors could jeopardize your retirement savings by suing you for the amount due. Instead, encourage federal loans, because the repayment terms are typically more flexible than private loans and are easier to get. Then, help him or her to repay the loans after he or she has earned a degree. Keep in mind that while you won’t affect the family’s financial aid eligibility, loan payments for another individual’s education are taxed, so do not repay more than $28,000 a year if you’re married or $14,000 if you’re single.
IRS Rules for Coverdell Education Savings Accounts
IRS Q&A on 529 Savings Plans