What Grandparents Should Know About Paying for College

What Grandparents Should Know About Paying for College

Grandparents are often there for the big events in their grandchildren’s lives – birthdays, holidays, awards assemblies, sports events.

Of course, they want to be involved in the really big one – 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 for their investment.

Sometimes grandparents have saved a lot of money and want to give it to their grandchildren for college. Write a check and call it a day. That’s great!

But there are savvier and smarter ways to do this that give tax breaks and savings to grandparents and help a student get more financial aid.

 

Is Paying College Tuition Exempt From Gift Tax?

A grandparent can pay for college tuition and they may considered it a gift, but luckily the IRS does not.

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, you should make the tuition payment directly to the student’s school – you should not give the money directly 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.

But there are downsides to paying tuition directly to the college. The main one is it affects a student’s financial aid eligibility.

Financial aid is based on formulas, and when calculated, the grandparents’ contribution may cost the student valuable financial aid. Also, such a gift of money may also be considered student income on the FAFSA.

Say, a grandparent pays $15,000 for tuition. That could reduce the aid eligibility by 50%.

Grandparents should remember that a tuition gift only applies to tuition when it comes to taxes. Room and board, supplies, and books are extra.

If grandparents can’t cover the entire cost of college including the extras, they should reconsider the way they pay for college.

 

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 fees 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 for whom you claim an exemption 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.

 

How Can Grandparents Pay for College?

Many grandparents create a 529 account or contribute to an account already set up by parents. These assets have no impact on a student’s financial aid eligibility initially.

But when the grandparent withdraws the funds to pay for college, the student feels a hit. That’s because that money is reportable on the next year’s FAFSA as student income, reducing financial aid. FAFSA uses the previous year’s tax returns.

Luanne Lee, a college planning coach, says that while 529 accounts are great, they should be used strategically.

“If the 529 monies are needed to help pay for the first 2 1/2 years of college, I suggest they transfer the 529 accounts to their adult child for the benefit of their grandchild,” Lee says.

“Although the monies will be counted as a parent asset on the FAFSA it is counted less than student income. If the funds aren’t needed until the spring semester of the junior year and later the income won’t be counted the following FAFSA filings.”

Lee has a story that she likes to share with grandparents about how 529s must be used carefully.

Years ago, Lee met with a family. The grandfather had a small 529 account for his daughter, who was a single mom with an income below $50,000, and his granddaughter who attended an out-of-state university.

The mother had taken out parents PLUS loans. The daughter had Stafford Student loans and Pell grants.

The grandfather thinking he was doing a good thing and sent his 529 to the school. But that wasn’t a great idea, even if it was a caring gesture. The granddaughter’s Pell Grant was taken away because suddenly she didn’t have as much financial aid.

It’s a good idea for grandparents to eventually transfer ownership of their 529 account to parents just before the student starts college.

 

What Grandparents Should Know About Paying for College

If grandparents have simply saved money in a savings account or in a CD, they can wait and help the student pay off student loans. That way, there is no impact on the grandchild’s financial aid eligibility.

Experts say that this may help the grandchild have an incentive to graduate, and the student can deduct loan interest of up to $2,500 on their tax return.

This plan also has some downsides. Loan payments are considered gifts. If a grandparent gives more than $15,000, a gift tax will kick in. If a grandparent dies or gets ill, that financial promise may not happen.

One way to be sure that helping a grandchild doesn’t impede on financial aid is for grandparents to withdraw money after the family has filed for financial aid in late winter or spring of a student’s junior year in college.

This will be the last financial aid application a family has to submit if the student is graduating in four years. Once that form is submitted, the college no longer asks about a family’s finances. Grandparents could then pay for the student’s senior year.

Grandparents could also help a student pay for books and living expenses instead of contributing outright for tuition.

Another way grandparents can share in the expense of college?

Grandparents can loan parents money. That debt won’t interfere with financial aid opportunities.

The loan must be a legitimate lending arrangement, and the grandparents need to charge interest. Grandparents should create documentation to show all of this in case any questions arise.

Once the student has graduated and the parents have finished paying for college, the grandparents can forgive the loan.

Grandparents shouldn’t avoid giving money to their grandchildren for college, but they should be savvy when offering to help, even seeking out a college financial coach for help.

Some grandparents may think that the college system is like it was forty years ago, and that is definitely not the case!

Research is key and so is communication with all parties – parents, student, other grandparents or relatives – who are paying for a student’s college.

That way, everyone involved will get the most for their money without tripping over any financial aid landmines.

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Suzi Parker

Suzi Parker

Suzi is an award-winning political and cultural journalist and author whose works have appeared in The Daily Beast, The Economist, The Christian Science Monitor, Reuters, The Washington Post, Town & Country, US News & World Report, and many other national and international publications.
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