Grand Gestures: Education Gifting Strategies for Grandparents

February 11, 2020
By Matt Cohen, CFP®, CIMA®

The cost of higher education has been rising at a rapid clip over the past decade, and with it the amount of student debt. Rising costs have not deterred student enrollment, but have dramatically impacted parents’ ability to pay for their children’s college experience through savings alone. A question we are hearing more and more from our clients – who are often the grandparents of soon to be, or already enrolled college students – is “how can I best give my grandchild the gift of education?” The answer can be a bit tricky, and depends on where the grandchild is on the road to higher education. I’ve segmented the popular options below by age group:

Stage 1: The Soon to be College Student
There are more options for students not yet enrolled in college, since time and compounding returns can be an advantage. At a basic level, the decision can boil down to either an outright gift or “earmarking” the funds without an immediate gift.

Outright Gifts:
Grandparent-owned 529 accounts are a popular choice, particularly if the child is young and has many years before going to college. Benefits of 529 plans include potential state income tax deductions, tax-free growth, and the ability to change beneficiaries. However, grandparent-owned distributions are treated differently on the Free Application for Federal Student Aid form (FAFSA). While they are not included as an asset on FAFSA, any distributions are treated as income to the child in the year of filing. A best practice is to use grandparent-owned 529 plans exclusively for the junior and senior years of college, thus minimizing the impact on financial aid eligibility. In addition, you may now withdraw up to $10,000 from a 529 plan during your lifetime to repay student loans without tax or penalty as a qualified educational expense.

Other options for outright education gifts are education trusts and Uniform Gift to Minors (UGMA) accounts. Education trusts are legal entities that guarantee money is spent in accordance with the trust agreement. The downside is the cost to establish the trust. UGMA accounts are another way to gift assets to a minor. Unlike a trust account, once the minor reaches the age of majority (18 or 21, depending on the state), he or she owns the account outright. Neither represents an ideal solution as they are both irrevocable gifts, reportable on the FAFSA form, and may have adverse tax implications.

Earmarking Strategy:
Another option to consider is to mentally, or physically, carve out a portion of assets for education purposes. While you may not be able to enjoy some of the tax or estate benefits associated with the above strategies, you do have control of the timing and disposition of funds for education. Estate planning for disposition of these funds in the event of an untimely death is imperative with this strategy.

Stage 2: The Current College Student
For grandchildren already enrolled in school, the options become a bit more limited. Tuition bills are already coming in, so 529 accounts are generally not great solutions, with two notable exceptions: potential for postgraduate education costs and/or gifting for estate tax purposes.

If you have used an earmark strategy, it’s advantageous to pay for the grandchild’s tuition directly with the school, rather than gift the money to the student. Direct tuition payments are not considered a gift, and thus not subject to gift tax. However, tuition payments are reportable on the student’s FAFSA application and will negatively impact financial aid.

Stage 3: Student Loans Last Longer Than it Took to Graduate
Now that the grandchild has graduated, he or she might be like the millions of their peers with a hefty student loan burden. If you choose to reduce or eliminate that burden, remember that the money used to pay off a grandchild’s student loan is considered a gift, and is thus subject to gift tax. Offering a low interest loan that could eventually be converted into a gift can save the grandchild a substantial amount in interest. If you pay off a grandchild’s student loan, consider setting expectations with regard to graduation and participation in future savings with the funds that would otherwise be used to pay off loan balances.

However you choose to participate, helping your grandchild get an education will have lifelong benefits. Please don’t hesitate to give us a call so we can help you make the most impactful gift to your grandchildren.

Matt Cohen, CFP®, CIMA®. 

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To view other articles in the February 2020 Financial Planning Focus newsletter, click here.

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