College Tuition Costs: The Best Ways for Grandparents to Help
By Amanda Reaume
As a retired psychology professor, Ruth Bookstaber thinks it’s important that her four grandsons get a good education. Twelve years ago, she started putting $100 a month into an investment account for each boy—now ranging in age from 7 to 17—to ensure they could afford any school they wanted to attend. Over the years, she has built a college fund of about $20,000 for each child.
“I realized that college was extremely expensive for my daughters, and I knew it would be worse for my grandkids,” said Bookstaber, 70. “If I can help, then I want to do that.”
According to the College Board, the average cost of tuition, fees, room and board at an out-of-state public four-year college for 2015-2016 was $34,031 per year. The expense makes paying for higher education difficult for many families. As a result, grandparents often step in to help their grandchildren with college costs, said Daniel P. McLennon, advanced planning attorney with Northwestern Mutual.
But grandparents should be careful about how they pitch in, he cautioned. At times, the extra assistance can inadvertently undermine financial aid. Any money given to students (or their parents) will be factored into calculating how much aid students are eligible for.
For grandparents who are interested in contributing to college costs, here are some ways to give without affecting financial aid or triggering other penalties, such as gift taxes.
Avoid Pitfalls of Grandparent-Owned 529 Plans
A 529 plan is a savings plans designed to help families save and pay for college. It comes with potential state income tax deductions for contributions, and money in the plan grows tax free.
Grandparents can save for their grandchildren’s education with a grandparent-owned 529 plan. The plan must list a student as the beneficiary, and distributed funds can be transferred to the student or directly to the school to pay expenses. But using these funds to help pay for your grandchildren’s college costs can greatly affect their financial aid. That’s because each grandchild will have to report that distribution the following year as untaxed income on the Free Application for Federal Student Aid, or FAFSA, a form the federal government and most colleges use to determine how much financial aid a family receives.
The FAFSA calculates how much a family is expected to contribute toward the cost of education by looking at income based on the previous year’s tax return and assets. Families are expected to contribute 50 percent of students’ eligible income and 20 percent of students’ assets toward their education, and 5.64 percent of parents’ eligible income and assets. So if you transfer $5,000 to your grandchild, his or her expected contribution could be $2,500 more the following year because that money will be counted as income.
There are ways to prevent this, according to McLennon. One way is to wait until after Jan. 1 of the student’s junior year to begin distributing funds from the grandparent-owned 529 plan. Money taken out after that date will not be reported on the FAFSA filed for senior year.
But that works only when the student doesn’t need the grandparent’s money before the latter part of junior year, McLennon said. This strategy also won’t work if the college the grandchild wants to attend uses the CSS/Financial Aid PROFILE in addition to the FAFSA. The PROFILE is another financial aid form used by over 300 schools to determine financial aid. It requires listing grandparent-owned 529 plans.
Another strategy to avoid the financial aid drawback is to transfer the whole 529 plan to the grandchild’s parents, said McLennon. Because the FAFSA assesses a parent’s assets at a rate of only 5.64 percent, if you transfer a 529 plan worth $20,000 to a parent, then the expected family contribution would increase by only $1,128 or less.
Although this strategy will work for most families, there are caveats. Your 529 plan may not allow you to transfer ownership. “That’s why it’s important to check whether your state allows you to transfer funds before setting up a grandparent-owned 529 plan,” said McLennon.
Non-529 Plan Options
There are other options for grandparents who want to assist with college costs without using a 529 plan. The simplest may be to pay their grandchildren’s tuition directly to the school.
There’s a tax exemption for those paying tuition directly to the school, which means such payments aren’t counted as taxable gifts, said McLennon. The paid tuition will still be recognized as the student’s untaxed income and can affect financial aid, but grandparents can avoid this by paying only after the final FAFSA is submitted.
Another option is for grandparents to pay off student loans after graduation, since this will have no effect on financial aid. This strategy requires understanding the limits of non-taxable gifts so that the family doesn’t face a large tax bill, McLennon said. Each person can give up to $14,000 a year, tax-exempt, in the form of student loan payments or gifts. Each person also has a lifetime gift tax exemption, which allows him or her to gift an additional $5.43 million over the course of a lifetime without incurring federal taxes.
Find the Right Fit for You
McLennon advises grandparents to use multiple methods when helping with the cost of college.
“Don’t put all your eggs in one basket,” he said. “Grandparents might decide to pay some costs with a 529 plan and some costs with cash to provide more flexibility.”
This will allow families to adapt if financial aid eligibility changes in the future.
Bookstaber chose not to save in a 529 plan and decided that the best strategy to help her grandchildren pay for school is to pay off their student loans. She’s excited that her oldest grandchild will be going to college next year.
“Right now, he’s considering Pomona, Harvey Mudd and Reed College,” she said, “which are expensive schools he might not be able to consider if he didn’t know that I was helping out.”
Amanda Reaume is a freelance writer and the creator of the blog Millennial Personal Finance. She is also the author of two personal finance books aimed at millennials: Money Is Everything and The Complete Guide to a Debt-Free Education.
Originally published on Northwestern MutualVoice on Forbes.com.