20 Jan Paying for a grandchild’s college

Q. I want to give money to pay for my grandson’s college. I’ve heard I can put it in a savings account or pay it directly to the college. What are the advantages or disadvantages?
— Grandma

A. You have several options to help your grandson.

For starters, you can make a direct gift of cash or securities to your grandson and/or his parents.

To avoid any gift tax implications you should keep your gift below the annual gift tax exclusion amount, which is $14,000 for 2016, said Jim McCarthy, a certified financial planner with Directional Wealth Management in Rockaway.

He said this amount is per recipient, so you could give up to $14,000 to your grandson and each of his parents, in any given year, without any gift tax, McCarthy said.

“The downside to this option is the potential impact on financial aid,” he said.

Every student applying to college should complete the Free Application for Federal Student Aid (FAFSA) regardless of whether they think they will qualify for financial aid.

“Any assets in your grandson’s name, including savings accounts, will be counted as useable assets on his FAFSA application,” McCarthy said. “Assets in his parent’s name will also be counted, but at a much lower level.”

Students are expected to contribute 20 percent of their assets each year toward college costs and parents are expected to contribute 5.6 percent of their assets each year to their child’s education costs.

You also have the option of paying directly to the college.

McCarthy said under federal law, tuition payments made directly to a college aren’t considered taxable gifts, no matter how large the payment. Only tuition qualifies for this federal gift tax exemption–room and board, books, and fees aren’t eligible.

“Paying tuition directly to the college also ensures that your money will be used for education purposes,” McCarthy said. “However, a direct tuition payment might prompt a college to reduce any potential financial aid your grandson might receive, so make sure to ask the college about the financial aid impact of your gift.”

You didn’t say how old your grandson is. If he’s younger than 16, you could consider funding a 529 plan account for him, McCarthy said.

“A 529 college savings plan is a tax-advantaged savings vehicle that can be a smart way for grandparents to contribute to their grandchild’s college education while paring down their own estate. You can open a 529 account yourself and name your grandson as beneficiary, or you can contribute to an already existing 529 account,” he said. “Contributions to your account grow tax-deferred and earnings are tax-free if the money is used to pay the beneficiary’s qualified education expenses.”

Contributions are subject to the annual gift tax limit of $14,000, but you can take advantage of a special five-year gifting rule for 529 plans which allows you to make five year’s worth of $14,000 gifts at one time. In that case, you’re frontloading your gifts, so you can’t also make them annually.

McCarthy said you should note that under current federal financial aid rules, grandparent-owned 529 plans are not counted as a parent or student asset, but withdrawals from a grandparent-owned 529 plan are counted as student income, which can affect financial aid eligibility in the following year.

For that reason, he usually recommends not taking withdrawals from a grandparent-owned 529 until after Jan. 1 of your grandson’s Junior year, which is when he will file his FAFSA for his senior year.

Parent-owned 529 plans are considered a “parent” asset for FAFSA but the withdrawals are not considered income, he said.

“If your grandson is 16 or older then I wouldn’t recommend using the 529 strategy as these accounts are subject to market fluctuations and are not well-suited for short time horizons,” he said.

So which option is best for you?

That depends on your goals and whether or not your grandson actually goes to college.

“If you pay a large lump sum to the college and for some reason plans change — i.e. student leaves the college — you may end up losing money,” said Vicky Tomaro, an Investment Advisor Representative with Tomaro Financial Group in Wall.

Tomaro said it makes sense for a grandparent to look at what the student has in their name and what is available to them, and how the gifting options could impact financial aid.

“My personal belief is that based on the relationship of the grandmother and the child, she would determine what might be best suited for the gift based on how responsible she feels the child is,” Tomaro said. “For example, would he/she pay the college directly or put it in a savings account to be used in whatever way they wish?”

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This story was first posted in January 2016.