Nicholson Financial Services, Inc.David S. NicholsonFinancial Advisor89 Access RoadSte. CNorwood, MA 02062781-255-1101866-668-1101david@nicholsonfs.comwww.nicholsonfs.com

How Grandparents Can Help Grandchildren with CollegeCosts

January 04, 2021

As the cost of a college education continues to climb,many grandparents are stepping in to help. This trendis expected to accelerate as baby boomers, many ofwhom went to college, become grandparents andstart gifting what's predicted to be trillions of dollarsover the coming decades.

Helping to pay for a grandchild's college educationcan bring great personal satisfaction and is a smartway for grandparents to pass on wealth withouthaving to pay gift and estate taxes. So what are someways to accomplish this goal?

Outright cash giftsA common way for grandparents to helpgrandchildren with college costs is to make anoutright gift of cash or securities. But this method hasa couple of drawbacks. A gift of more than the annualfederal gift tax exclusion amount — $15,000 forindividual gifts and $30,000 for gifts made by amarried couple in 2021 — might have gift tax andgeneration-skipping transfer (GST) tax consequences(GST tax is an additional gift tax imposed on giftsmade to someone who is more than one generationbelow you). Another drawback is that a cash gift to astudent will be considered untaxed income by thefederal government's aid application, the FAFSA, andstudent income is assessed at a rate of 50%, whichcan impact financial aid eligibility.

One workaround is for the grandparent to give thecash gift to the parent instead of the grandchild,because gifts to parents do not need to be reportedas income on the FAFSA. Another solution is to waituntil your grandchild graduates college and then givea cash gift that can be used to pay off school loans.Yet another option is to pay the college directly.

Pay tuition directly to the collegeUnder federal law, tuition payments made directly to acollege aren't considered taxable gifts, no matter howlarge the payment. So grandparents don't have toworry about the $15,000 annual federal gift taxexclusion. But payments can only be made for tuition

— room and board, books, fees, equipment, and othersimilar expenses don't qualify. Aside from the obvioustax advantage, paying tuition directly to the collegeensures that your money will be used for theeducation purpose you intended, plus it removes themoney from your estate. And you are still free to giveyour grandchild a separate tax-free gift each year upto the $15,000 limit ($30,000 for joint gifts).

However, colleges will often reduce a student'sinstitutional financial aid by the amount of thegrandparent's payment. So before sending a check,ask the college how it will affect your grandchild'seligibility for college-based aid. If your contribution willadversely affect your grandchild's aid package,particularly the scholarship or grant portion, considergifting the money to your grandchild after graduationto help him or her pay off student loans.

529 plansA 529 plan can be an excellent way for grandparentsto contribute to a grandchild's college or graduateschool education, while simultaneously paring downtheir own estate. Contributions to a 529 plan grow taxdeferred, and withdrawals used for the beneficiary'squalified education expenses are completely tax freeat the federal level (and generally at the state level,too). Participation in a 529 plan isn't restricted byincome level and lifetime plan contribution limits arehigh, typically $350,000 and up (limits vary by state).

There are actually two types of 529 plans: savingsplans and prepaid tuition plans. A 529 savings plan isan individual investment account where you directyour contributions to one or more of the plan'sinvestment portfolios, similar to a 401(k) plan. Fundsin the account can be used to pay total qualifiedexpenses (i.e., tuition, fees, room and board, books,supplies) at any accredited college in the UnitedStates or abroad. Funds can also be used to payK-12 tuition expenses, up to $10,000 per year. Bycontrast, the less common 529 prepaid tuition planallows you to purchase college tuition credits attoday's prices for use in the future at a limited group

Paying the college

Tuition payments madedirectly to a college aren'tconsidered taxable gifts, nomatter how large thepayment. But this is trueonly for tuition, not roomand board, books, or fees.

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of colleges that participate in the plan, typicallyin-state public colleges.

Grandparents can open a 529 account and name agrandchild as beneficiary (only one person can belisted as account owner, though) or they cancontribute to an already existing 529 account.Grandparents can contribute a lump sum to agrandchild's 529 account, or they can contributesmaller, regular amounts.

Regarding lump-sum gifts, a big advantage of 529plans is that under special rules unique to 529 plans,individuals can make a single lump-sum gift to a 529plan of up to $75,000 and married couples can makea joint gift of up to $150,000 (which is five times theannual gift tax exclusion) and avoid federal gift tax. Todo so, a special election must be made to treat thegift as if it were made in equal installments over afive-year period, and no additional gifts can be madeto the beneficiary during this time.

Example: Mr. and Mrs. Brady make a lump-sumcontribution of $150,000 to their grandchild's 529 planin Year 1, electing to treat the gift as if it were madeover 5 years. The result is they are considered tohave made annual gifts of $30,000 ($15,000 each) inYears 1 through 5 ($150,000 / 5 years). Because theamount gifted by each grandparent is within theannual gift tax exclusion, the Bradys won't owe anygift tax (assuming they don't make any other gifts tothis grandchild during the 5-year period). In Year 6,they can make another lump-sum contribution andrepeat the process. In Year 11, they can do so again.

Significantly, this money is considered removed fromthe grandparents' estate, even though in the case of agrandparent-owned 529 account the grandparentwould still retain control over the funds. There is acaveat, however. If a grandparent were to die duringthe five-year period, then a prorated portion of thecontribution would be "recaptured" into the estate forestate tax purposes.

Example: In the previous example, if Mr. Brady wereto die in Year 2, his total Year 1 and 2 contributions($30,000) would be excluded from his estate. But theremaining portion attributed to him in Years 3, 4, and5 ($45,000) would be included in his estate. Thecontributions attributed to Mrs. Brady ($15,000 peryear) would not be recaptured into the estate.

If grandparents want to open a 529 account for theirgrandchild, there are a few things to keep in mind.

If you need to withdraw the money in the 529 accountfor something other than your grandchild's collegeexpenses — for example, for medical expenses oremergency purposes — there is a doubleconsequence: the earnings portion of the withdrawalis subject to a 10% penalty and will be taxed at yourordinary income tax rate. Also, funds in agrandparent-owned 529 account may still be factoredin when determining Medicaid eligibility, unless thesefunds are specifically exempted by state law.

Regarding financial aid, grandparent-owned 529accounts do not need to be listed as an asset on thefederal government's financial aid application, theFAFSA. However, distributions (withdrawals) from agrandparent-owned 529 plan are reported as untaxedincome to the beneficiary (grandchild), and thisincome is assessed at 50% by the FAFSA. Bycontrast, parent-owned 529 accounts are reported asa parent asset on the FAFSA (and assessed at 5.6%)and distributions from parent-owned plans aren'tcounted as student income. To avoid having thedistribution from a grandparent-owned 529 accountcount as student income, a grandparent can delaytaking a distribution from the 529 plan until any timeafter January 1 of the grandchild's sophomore year ofcollege (because subsequent FAFSAs will rely onincome tax returns from previous years). Anotheroption is to wait until after the grandchild graduatesand use 529 funds to help pay down his or herstudent loans (there is a $10,000 lifetime limit per 529plan beneficiary on repaying student loans).

Colleges treat 529 plans differently for purposes ofdistributing their own financial aid. Generally,parent-owned and grandparent-owned 529 accountsare treated equally because colleges simply require astudent to list all 529 plans for which he or she is thenamed beneficiary.

Note: Investors should consider the investmentobjectives, risks, charges, and expenses associatedwith 529 plans before investing; specific planinformation is available in each issuer's officialstatement. There is the risk that investments may notperform well enough to cover college costs asanticipated. Also, before investing, consider whetheryour state offers any favorable state tax benefits for529 plan participation, and whether these benefits arecontingent on joining the in-state 529 plan. Otherstate benefits may include financial aid, scholarshipfunds, and protection from creditors.

Did you know ...

• If your grandchilddoesn't go to college orgets a scholarship, youcan name anothergrandchild as 529account beneficiary withno penalty

• Many states offerincome tax deductionsfor contributions to their529 plan

• Money in a 529 savingsplan can be used forK-12 tuition expensestoo, up to $10,000 peryear

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