How Can Grandparents Help Fund College?

With the rising cost of higher education, more grandparents may be interested in helping pay for their grandchildren’s college expenses. As with any major financial decision, the first place to start is by having a conversation with all involved individuals. Together, you should talk through potential savings plans and look at how each strategy will affect everyone involved—grandparents, parents, and the child included. The following three account options are some of the most popular college savings vehicles, all with unique tax advantages and different implications for each generation. Read on to discover how grandparents can help fund college.

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529 Plans 

This is often the first college savings option that comes to mind, and for good reason. With a 529 plan, contributions are made with after-tax money, but earnings and withdrawals are tax-free on qualified expenses (a 10% penalty and income tax must be paid on any unqualified expenses). Once contributions have been made to a 529 plan, the contributions are no longer part of the contributor’s estate. This means that estate taxes do not apply to the contributions. Whoever opens the account, whether parent or grandparent, maintains control of that account and may make any changes they wish, even changing the beneficiary on the account. 

Though 529 plans are often associated with college savings, elementary, middle, and high school tuition are also qualified expenses. The catch is that only $10,000 per beneficiary per account can be spent on these lower education expenses. Anything over the $10,000 threshold will be charged a 10% federal penalty, and income tax will apply. More flexibility is provided at the college level, where funds can cover tuition as well as books, fees, supplies, etc. 

Though the 529 plan has many benefits, there are also some potential disadvantages. Distributed money is considered student income, which may affect the child’s financial aid. The investment options are also fairly limited—for example, you cannot invest in individual stocks. Another major concern for grandparents may be that a 529 plan could affect their Medicaid assistance. In these cases, the funds from their 529 plan would need to be spent prior to beginning Medicaid payments.

Uniform Gifts to Minors Act (UGMA) or Uniform Transfers to Minors Act (UTMA) 

The major benefits of UGMA/UTMA accounts are that they offer considerably more investment options than 529 plans and there are no contribution limits. These accounts offer a unique characteristic: with UGMA/UTMA accounts, once children come of age, they have full control over the money and there are no limits or requirements on how the money can be spent. If a child decides to buy a car instead of spending the money on school, they would be able to do so. But this also means that if the child chooses not to attend college, the funds could still be of use without incurring any penalties. 

A potential concern for parents or grandparents is that contributions are considered part of the parents’ or grandparents’ estate for estate tax purposes. In regards to the child, these accounts may also negatively impact financial aid. The funds are considered student assets, which are factored into the Expected Family Contributions (EFC) at 20% as opposed to parental assets, which are factored in at 3%-5.6%. 

Coverdell Education Savings Accounts (ESAs) 

Coverdell ESAs are another account option to help save for education expenses. They offer much more flexibility on how the funds are used—with the ability to fund anything from kindergarten to college. Earnings and withdrawals are tax-free (as long as you don’t also claim an American Opportunity credit or Lifetime Learning credit in the same year for those same expenses). Once contributions are made, the contributions are not considered part of the parents’ or grandparents’ estate. Coverdell ESAs also offer more investment options than 529 plans. 

The major downside to a Coverdell ESA is that the annual contribution limit is only $2,000. Since the limit is for all contributions for a beneficiary, if multiple individuals are contributing to the account, it may be easy to overcontribute, which can result in a penalty. Also, contributions may only be made if income is under a certain amount. There is not a specific law keeping grandparents from opening Coverdell ESAs, but most require that the person responsible for the account be the child’s parent or guardian. If the grandparents are contributing to an account in the parents’ name, the grandparents no longer have control over the funds once they have been contributed. 

Which Option is Right for You? 

It may not be as simple as picking one solution if you’re a grandparent wanting to help fund college. For example, you may find it beneficial to combine features of custodial accounts with 529 plans.

Speak with an advisor at Good Life Financial Advisors to discuss your college savings plan options.

DISCLOSURE

Prior to investing in a 529 Plan, investors should consider whether the investor’s or designated beneficiary’s home state offers any state tax or other state benefits such as financial aid, scholarship funds, and protection from creditors that are only available for investments in such state’s qualified tuition program. Withdrawals used for qualified expenses are federally tax free. Tax treatment at the state level may vary. Please consult with your tax advisor before investing.

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