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Money December 2015

Dollar Sense

Helping the Grandkids Pay for College

By Teresa Ambord

Students are expected to contribute 20% of their own assets toward college. Parents, however, are only expected to give 5.6% of their assets. So if need-based aid is a factor, the grandchild would qualify for more financial assistance if the parents have the funds you provide.

Starting young is the key, of course. Money that you set aside now to send your new grandbaby to college someday obviously has the best chance of growing into something substantial. Depending on how you do it, it can also minimize your taxable estate when you pass away.

You may already know that you and your spouse can each give $14,000 per year to any number of recipients, without causing them any tax liability (and at the same time you are reducing your taxable estate). By the time your grandchild reaches college age, you’ve created a nice financial package.

You can also pay unlimited medical and tuition expense for him or her (or other family members) without incurring any gift tax issues for yourself, as long as you pay the amounts directly to the health care provider or the school. This is true even for preschool, and for a child of any age.

It’s generally better to give the money for your grandchild’s college needs to his or her parents, assuming you feel secure doing that. Why? Because students are expected to contribute 20% of their own assets toward college. Parents, however, are only expected to give 5.6% of their assets. So if need-based aid is a factor, the grandchild would qualify for more financial assistance if the parents have the funds you provide.

 

A 529 Plan

A 529 college savings plan allows you to sock money away now, and let it grow, tax-free (as long as the money is later used for higher education). Currently these plans are sponsored by 48 states and the District of Columbia. If the child is very young, you may think there’s plenty of time to start such a fund.

But college costs are enormous today, and growing. For the 2014-2015, a public in-state college year cost over $9,100, while a private, college is over $31,200 according to Trends in College Pricing, 2014, put out by the College Board.

What are your options for a 529 plan? If your grandchild’s parents already have a 529 established, you can contribute to it. There’s little for you to do in terms of managing the account, but you also have no control over the account. Also, as noted above, money in a plan that belongs to the grandparents will later be consider owned by the student, and that will make the student eligible for less financial aid based on need.

Or you can set up an account yourself and name your grandchild as the beneficiary. You choose where to open the account, whether to handle it yourself or use a broker or other financial institution, and how aggressively to invest the money. There’s one drawback, however. If your child applies for financial aid, a plan owned by the grandparents could affect his or her ability to qualify for need-based aid. The federal rules that determine eligibility look at 529 plan funds from a grandparent-owned account as being “untaxed income” to the student. Merit based scholarships would not generally be affected by contributions from the grandparents or the parents.

A viable alternative if you want to maintain control in the early years, is to open the account in your name and later, transfer ownership to the grandchild’s parents.

If you’re still working, you may be able to contribute to a plan through a payroll deduction. The maximum you can contribute overall, to most 529 plans is $300,000 to a single beneficiary, and your income is not a factor. Another option is the prepaid plan (offered in 12 states).

You can prepay all or a portion of the cost of an in-state public college. Later, if your grandchild decides to go instead to a private or out-of-state school, you can get a refund or transfer the money to another school, although it likely will not cover the full cost.

 

How Much can You Contribute?

Generally the limits are the same as the cash gift limits, which in 2015 are $14,000 per year per recipient (and $28,000 per year per recipient for married couples). There is also a special rule which allows you to frontload a 529 plan with five years’ worth of contributions. This amounts to $70,000 from you or $140,000 from you and your spouse ($14,000 x 5 years, or $28,000 x five years).

By frontloading in this way, the money has additional time to grow and you get the immediate benefit of five years’ worth of annual federal gift tax exclusions. You avoid income tax and estate tax on the earnings that would accumulate on the frontloaded amount. It does require that you fill out a special tax form (IRS Form 709) indicating that you’ve taken the frontloading option. And, if you should pass away before the five years is up, the pro-rata portion of the contribution is added back to your estate for federal estate tax purposes.

 

What about Custodial Accounts?

You can also set aside money for the grandkids without specifying that it be used for college. Depending on which state you’re in, this might be a Uniform Gift to Minors Account or a Uniform Transfer to Minors Account. There are no limits to how much you can contribute, but if you exceed the above-mentioned limit of $14,000 per year per recipient ($28,000 for married couples), there will likely be some gift tax implications.

If managing such an account is not something you’re interested in doing, you can always name someone — a bank representative or a family member or friend — to be the trustee while the child is young. A custodial account keeps the money safe for the benefit of the child. Sadly, many grandparents take this alternative because they know they can’t really trust the grandchild’s parents to not use the money for purposes other than the child’s education.

One drawback of a custodial account is that it includes investment income exceeding a certain amount, it could be hit with “Kiddie Tax.” For 2015 and 2016, that amount is $2,100. Anything over that will be taxed at the parents’ tax rate, which is almost certain to be higher. So for example, if the custodial account for your granddaughter earns $3,000 in investment income in 2016, the first $2,100 will be subject to the child’s low tax rate, and the remaining $900 will be taxed at the parents’ higher tax rate.

Another potential drawback is that, depending on the law in your state, the account funds become the property of the child when he or she reaches 18 or 21. Your grandchild may be a budding genius, but keep in mind, when trusted with a large sum of cash, even a genius can become irresponsible.

 

One Final Way to Help the Grandkids

You can always name your grandchild in your will, or make him or her a beneficiary of your life insurance. The great thing about this road is, you don’t have to have the finances now to establish that for the future.

A last thought… it’s great to want to help your grandkids with college costs. But don’t do it at the risking of your retirement security. Your kids and especially your grandkids have decades of earning power left. You don’t. If you jeopardize your retirement security, even for a noble purpose like paying for college, you could end up sharing a set of bunk beds with the grandkids. Don’t do it.

 

Teresa Ambord is a former accountant and Enrolled Agent with the IRS. Now she writes full time from her home, mostly for business, and about family when the inspiration strikes.

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