Grandparents are often there for the big events in their grandchildren’s lives—birthdays, holidays, awards assemblies, and sports events.
Of course, they also want to be involved in a really big one—going to college.
Many grandparents have saved wisely over the years for retirement and their families, and they want to help put their grandchildren through college.
It may seem as simple as writing a check to the college, but that’s not necessarily the smartest way to get the most out of their investment. Sometimes grandparents have saved a lot of money and want to give it directly to their grandchildren for college. They write a check and call it a day, and that’s great!
But there are savvier and smarter ways to pay for a grandchild’s education that give tax breaks and savings to grandparents and help a student get more financial aid.
529 Plans and Financial Aid
One of the most effective tools grandparents can use is a 529 plan. These plans allow contributors to prepay or save for qualified higher education expenses. Contributions to a 529 plan are made with after-tax dollars, but they grow tax-free and can be withdrawn tax-free for qualified educational expenses.
Previously, distributions from a grandparent’s 529 plan were treated as untaxed student income on the FAFSA, reducing aid eligibility by up to 50% of the distribution amount. However, thanks to the FAFSA Simplification Act, this has changed for the 2024–25 academic year.
Under the new FAFSA rules, distributions from a grandparent-owned 529 plan no longer affect a student’s financial aid eligibility. Students are no longer required to report cash support or 529 contributions from grandparents, making it easier for grandparents to support their grandchildren’s education without jeopardizing financial aid.
It’s important to note that this change only applies to the FAFSA. At institutions that use the CSS Profile for financial aid, grandparent-held 529 plans may still impact financial aid eligibility.
Is Paying College Tuition Exempt From Gift Tax?
A grandparent can pay for college tuition and they may consider it a gift, but luckily the Internal Revenue Service (IRS) doesn’t. Typically, the full cost of college tuition would run afoul of the IRS’s limits on gift taxes for gifts greater than $17,000 per year, but if the money is going straight to the college and is for tuition, there is another way.
A special tax-code exemption allows a grandparent to pay college tuition and not have that money subjected to gift tax. The IRS makes an exclusion in the case of financial gifts used for tuition payments.
The exclusion, called the Gift Tax Education Exclusion for Tuition, means that money gifted to a friend or family member to pay for college tuition is not subject to the federal gift tax. Under the Internal Revenue Code, you can pay unlimited amounts for someone’s tuition and not be taxed.
To make a tuition gift that qualifies for the federal gift tax educational exclusion, the gift-giver should make the tuition payment directly to the student’s school—they should not give the money to the student.
Paying the school directly, instead of donating to a student’s 529 plan helps grandparents avoid potential gift taxes if they plan to make significant contributions. Of course, it’s not just the grandparent’s finances that must be considered, but also the student’s. Luckily, that is about to get easier.
In the past, grandparents faced issues when trying to pay for their grandchildren’s tuition. However, with the arrival of the new Free Application for Federal Student Aid (FAFSA), a major change is coming that will be very beneficial.
Those who file the FAFSA are no longer asked if their grandparents will be providing any assistance. This means that students whose grandparents pay part of their college expenses will no longer see their financial aid decrease, as long as the grandparents know how to properly give the money. Allocating the money to the student helps make sure that the gift doesn’t impact future financial aid, at least until the new FAFSA comes into effect in 2024-25.
Can Grandparents Get a Tax Deduction for Paying for College?
Grandparents don’t qualify for the Lifetime Learning Credit or the refundable American Opportunity Tax Credit unless the grandchild is their dependent.
The same rule applies to tuition and fee deductions. According to the IRS, in order to claim either of these tax credits, the eligible student has to be “yourself, your spouse, or a dependent you listed on your tax return.”
If grandparents decide to contribute directly to their grandchild’s 529 plan, they may be able to claim the deduction. This will depend on whether they live in one of the states that offer a state income tax deduction for 529 college savings plan contributions. In addition, each of these states has differing stipulations on whether only the 529 account owner can take a deduction or if anyone who contributes to the 529 is eligible for the deduction.
So grandparents will need to do a little research to know their specific answer before deciding whether or not to contribute to their grandchild’s 529 plan.
Tax-Free Rollovers to Roth IRAs
Grandparents who save in a 529 plan may wonder what happens to unused funds if the grandchild doesn’t attend college or doesn’t use the full amount. A new benefit allows unused 529 funds to be rolled over tax-free into a Roth IRA, provided certain conditions are met.
For example:
- The 529 account must be at least 15 years old.
- Contributions made within the last five years are ineligible for rollover.
- Rollovers are subject to annual Roth IRA contribution limits and lifetime limits for the beneficiary.
- The beneficiary must have earned income at least equal to the amount rolled over.
This provision ensures that unused 529 funds can continue to grow tax-free for the beneficiary’s future retirement savings.
How to Strategically Use a 529 Plan
Experts recommend using 529 plans strategically to maximize financial aid and tax benefits. For instance:
- Grandparents could transfer ownership of a 529 plan to the student’s parents, as parental assets have a smaller impact on financial aid than student income.
- Alternatively, grandparents might wait to use 529 funds until the student’s junior or senior year, when FAFSA no longer considers untaxed income from prior years.
Other Ways Grandparents Can Help
If grandparents prefer not to use a 529 plan, they can explore other options, such as:
- Waiting until after the student graduates to help repay loans, which won’t affect financial aid eligibility.
- Paying for non-tuition expenses like books and living costs directly to the student or the parents, provided they stay within annual gift tax limits.
- Loaning money to parents under a formal agreement, which can be forgiven later as a gift.
Final Thoughts
Some grandparents may think that the college system is like it was 40 years ago, and that is definitely not the case! Research is key. Grandparents should consider consulting a college financial planner to navigate the complex landscape of financial aid, tax benefits, and savings strategies. Effective communication with parents and students is also crucial to ensure the best outcomes for everyone involved.
With careful planning and a full understanding of the updated FAFSA rules and tax implications, grandparents can play a significant role in supporting their grandchildren’s educational aspirations while maximizing their financial contributions.
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