Anyone who is old enough to have grandchildren remembers when it was possible to earn enough money from summer and part-time jobs to cover college tuition. Now, unless your grandchildren create the next Snapchat or
Over the past 40 years, tuition has increased at more than twice the inflation rate, straining family finances and forcing millions of young adults to take on student debt. Grandparents are eager to help. A 2014 survey by
But helping your grandchildren obtain a college degree is more complicated than mailing them a check on their 18th birthday. Any gifts you give may have tax implications for you (for better or for worse). And if the kids apply for financial aid, your generosity could backfire. Here's how to help the grandkids in the most effective way.
1. Invest in a 529 savings plan
Sukaskas contributes through payroll deduction and adds extra payments to the accounts on holidays and other special occasions. "If they get a toy, they play with it an hour or so, and that's about it," she says. "I'd rather have something waiting for them when the time comes for them to attend college."
Sponsored by 48 states and the
In addition to tax-free growth on your investment, you could get a tax break on your contributions. Thirty-three states and the
Unlike other education savings vehicles, 529 plans have high contribution limits: Most plans allow you to invest
Another option under the 529 umbrella is a prepaid plan. These plans let you prepay all or a portion of the cost of an in-state public college. If your grandchild decides to go to a private or out-of-state school, you can get a refund or transfer the money, though it won't necessarily cover all of the costs. Tax benefits and penalties are the same as for 529 savings plans. Only 12 states offer prepaid plans; the
Estate planning. Contributions to a 529 plan will reduce the size of your estate, a benefit you shouldn't ignore. While up to
You can contribute up to
Impact on financial aid. Money held in a grandparent's 529 plan isn't counted as an asset on the Free Application for Federal Student Aid (FAFSA), which is used to determine a student's eligibility for financial aid. However, when you take withdrawals to pay for your grandchild's college expenses, those distributions are treated as the child's income on the following year's FAFSA. The income will reduce financial aid on a dollar-for-dollar basis, says
To get around this problem, you could wait to withdraw money from the 529 plan until your grandchild is a college junior and has filed the FAFSA for the last time, in which case it won't affect her eligibility for financial aid in her senior year. Or, if your grandchild needs the money earlier, consider switching ownership to the child's parents. Only up to 5.64% of a parent-owned 529 plan's value is counted as an asset in the FAFSA formula, says
Another option is to make contributions to the parent's 529 plan. The downside is that you give up control of the account, but some states will still allow you to deduct your contributions, Hurley says.
2. Contribute to a Coverdell
Like money invested in 529 plans, funds invested in a Coverdell education savings account grow tax-deferred. Withdrawals aren't taxed as long as the money is used for qualified educational expenses. You can set one up at a bank or brokerage firm, giving you more investment choices than you have with a 529 plan. The maximum you can contribute, though, is
You don't maintain the same control over a Coverdell account as you do with a 529 plan. Most Coverdell account agreements require that the parent or guardian be named as the individual responsible for the account. That means you wouldn't be able to transfer the money to another beneficiary or use it for yourself.
You can contribute to an existing Coverdell as long as the total contributions per beneficiary don't exceed
3. Pay the bill yourself
Another way to avoid estate taxes is to pay your grandchild's tuition directly. Tuition payments aren't considered taxable gifts, so you don't have to file a gift tax return, even if the amount exceeds the annual limit. You must make the payment directly to the college (not the parents or grandchild), and the exemption only covers tuition. Payments for other costs, such as room and board, are subject to gift tax limits.
Direct gifts will reduce or eliminate your grandchild's eligibility for need-based financial aid. For that reason, consider this option only if you're sure your grandchild won't qualify for aid, or wait until the last FAFSA has been filed to make the payment.
4. Set up a custodial account
With these accounts, known as UGMAs (for the
In addition, the account is considered the child's asset, which will significantly reduce eligibility for financial aid. Full-time students younger than age 24 pay no tax on the first
5. Pay off student loans
Cosigning a private student loan will help your grandchild get a lower interest rate, but you're responsible for the debt if your grandchild defaults or falls behind. Debt collectors could sue you to collect the amount due, jeopardizing your retirement savings.
A better option is to encourage your grandchild to stick with federal loans, which are easy to get and have more-flexible repayment terms than private loans, then help repay the loans after graduation. This strategy won't affect the family's eligibility for financial aid. Loan payments on behalf of someone else are considered taxable gifts, so limit your repayments to
6. Kick in from your Roth IRA
Tapping your Roth is an option if you've already funded your retirement. As long as you're at least 59½ and have owned the Roth for at least five years, you can withdraw the earnings without paying taxes or penalties (you can withdraw contributions tax- and penalty-free at any time). If you give the money directly to the grandchild's parents after they've filed the FAFSA, it will have no impact on financial aid, as long as they use the money to pay the tuition bill before filing the FAFSA for the following year. (This strategy would work with any gift you provide, not just withdrawals from a Roth.)
You can't save as much in a Roth as you can in a 529 plan. In 2015, the maximum amount you can invest in a Roth is
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Sandra Block is a senior associate editor for Kiplinger's Personal Finance. .