Here’s how you can help your grandchildren pay for college
The cause-and-effect relationship between rapidly rising tuition costs and crippling student loan debt has made financing higher education a multi-generational event for some families.
Students contribute whatever they’ve been able to earn in low-income, part-time jobs. Parents try to figure out how to earn more, borrow more, or modify their budget to manage college costs. And now, with the Baby Boom generation racing into their mid-60s en masse, more and more of them are thinking of ways to help their grandkids pay for school.
Contributing to higher education is a common goal of grandparents and I’ll offer a few uncommon tips for participating. But first, it wouldn’t be good advice without a word of caution.
If you’re a grandparent who thinks it would be nice to pitch in to assist with tuition costs, it’s imperative that you first make sure your retirement is secure. It’s important not only to estimate your long-term income needs first but to confirm that there is enough margin of safety in your plan that if your expenses are higher than expected, your life is longer than expected or investment returns are less than expected, then you still have resources to supplement Social Security. You don’t want to fast forward 10 years or more and realize that you probably shouldn’t have paid as much tuition or other expenses for your grandkids.
That said, here are three options for grandparents to consider when helping with college costs.
BE THE 529 OWNER AND WAIT
Section 529 plans are investment vehicles that provide tax-free growth if the money in the account is used for qualified higher education expenses. When 529s are owned by parents, the underlying assets are included in the federal student aid application – known as the FAFSA. But when grandparents own the 529 account, those assets are not included. This may allow the student to qualify for more advantageous aid.
There is a caveat. Once funds in the 529 are used by the student, they are considered untaxed income and reported on the following year’s federal aid application. To get around unintentionally reducing aid eligibility, wait until the final year of college to use the 529 assets owned by the grandparent. They can be used for any qualified higher education expense, not just for tuition. Room and board, books and lab fees all apply.
BE THE BANK
With obscenely low interest rates on CDs, money market funds and Treasury bonds, many retired grandparents are being punished with negative after-inflation returns on their “risk-free” savings. On the flip side, most education loans still come at higher interest rates than borrowers would prefer to pay.
A convenient way to solve both problems is to have the grandparent provide the student loan. That way, it’s not a gift with no return. The loan can be structured with a higher interest rate than the grandparent can earn on cash but that rate can still be lower than federal or private student loans.
It’s best to do this through an official loan agreement, outlining terms and payback expectations. You have to follow guidelines so that the IRS doesn’t view the loan as a gift. For June, the applicable federal rate – the minimum amount of interest allowable – is 1.07 percent for mid-term loans of three to nine years. Charging more is not a problem. You could double that rate and still provide a big break compared with traditional student loans.
You both win and the interest stays in the family instead of going to a bank.
ESTATE PLANNING THROUGH GIFTING
In some scenarios, loans or qualifying for financial aid are not important considerations. Instead, the goal is to manage a tax-efficient estate plan through gifting. Grandparents can reduce estate tax exposure by contributing to a 529 for a grandchild. The money is removed from their estate but they retain control over it.
In most cases, an individual can gift up to $13,000 to any other person without owing gift taxes in any single year. In the case of funding a 529 plan, a special lump sum of $65,000 per child, per grandparent (making $130,000 the true maximum) could be given. This leverages a five-year front-loaded contribution rule specific to these college savings accounts. More money in the plan, ideally compounding returns over a longer period of time, theoretically would help keep up with tuition inflation.
A challenge for some grandparents comes in considering how to fairly support multiple grandchildren. There could be a wide range of tuition costs or support needed from one school or one child to the next. As with most money considerations, it’s best to make decisions based on a thorough plan that aligns your goals with your financial resources.
Gary Brooks is a certified financial planner and the president of Brooks, Hughes & Jones, a registered investment adviser in Old Town Tacoma. Reach him at email@example.com.