Back in the day, it was possible to pay for college by working over the summer and holding down a part-time job during the semester. Today, no kid is going to be able to put themselves through school this way. Tuition has increased at more than twice the rate of inflation over the past 40 years, making it difficult for all but the richest families to pay for college.
Many grandparents are chipping in to help out with educational expenses. In addition to being a lovely thing to do, it can also be a great way to reduce estate taxes. However, it is important to carefully plan out a strategy for how payments will be made. Simply writing a check could have gift tax implications for you, and reduce the financial aid your grandchild is eligible for.
529s
529 savings plans are one of the most popular educational finance tools because they have many tax advantages.
The earnings on investments in these accounts, which are sponsored by 48 states and the District of Columbia and managed by large mutual fund companies, grow tax-free. Withdrawals are also tax-free so long as the money is used for educational expenses like tuition, fees, and room and board.
The contribution limits on 529s are high, and you can participate no matter what your income level is. As an added bonus, some states provide a tax write-off for at least a portion of all contributions.
The only downside to 529 plans is that they can reduce the amount of financial aid your grandchild is eligible for. If your grandchild is counting on financial aid to cover their costs, it is best wait until he or she has filled out the FAFSA and gotten financial aid offers from the school they wish to attend. A financial planner can then work with you and your grandchild to figure out the best path forward.
Direct Payments to the Institution
Another way to get tax benefits for your generosity is to pay your grandchild’s tuition bill directly. Tuition payments aren’t considered taxable gifts, so any payments directly to the college won’t count toward your annual gifting limit.
Payments must go directly to the institution, not to your child or grandchild. Financial aid offices are happy to answer questions about how to do this if you need assistance. It is also worth contacting the school to see if you can pay with securities, which provides you additional tax benefits.
Note that non-tuition expenses do not get the same tax treatment. Paying for things like fees, books, and room and board must be accounted for in a gift tax return.
Paying for a grandchild’s tuition will also impact his or her financial aid eligibility. This is another situation where you should wait until your grandchild has filled out the FAFSA and gotten information about their financial aid options before proceeding.
Wait Until Junior Year
If your grandchild’s financial aid package will be negatively impacted by any money given to them or spent on their behalf, it might be worth waiting until he or she is in his or her junior year of college before sending any money out. The FAFSA is not filed again after junior year, so financial aid will not be impacted by money the student has access to.