How grandparents can help keep college debt down

Three planning tools to minimize student loans

By Kimberly Clouse

Nov 10, 2014 @ 2:04 pm EST

In an age in which soaring college tuition generates seemingly interminable financial debt, grandparents are increasingly interested in identifying the most effective ways to ease the financial burden on their children and grandchildren.

In weighing the available options, a wise grandparent should consider the various tax and financial aid implications of providing such assistance, as well as such personal considerations as his or her own age, health, and wealth level.

One of the best ways of providing financial assistance is by funding a 529 plan - an education savings plan operated by a state or educational institution, intended to assist families in reserving funds for future college costs. 529 plans offer significant benefits, chief among them that assets invested in a 529 plan grow tax-deferred and withdrawals for qualified educational expenses are federal (and in some cases state) income tax-free.

Many states also offer income-tax deductions for 529 plan contributions. 529 plans offer the owner simplicity and flexibility in asset management, as a plan's assets are professionally managed either by the state treasurer's office or an investment firm, such as Vanguard or Fidelity. And, perhaps best of all, 529 plans allow a grandparent to remain in complete control of the assets until the time at which the money is needed for education expenses - the named beneficiary generally has no right to the funds in the account, which may always be withdrawn by the donor, if needed. Withdrawals are subject to a 10% penalty plus tax on earnings.

Contributions to qualified 529 plans are eligible for the $14,000 per person annual gift tax exclusion (or $28,000 per person, if gifted by a married couple). Annual exclusion gifts to a grandchild's 529 plan, therefore, are an effective way of gifting assets to a younger generation and reducing the estate taxes that will be due at the grandparent's death. And if the grandparent's age and health are a concern, 529 plans offer a pre-funding option.

Attorney Amy B. Noughton, an estate and tax planning attorney with Boston, Mass.-based Lourie & Cutler, P.C., suggests that, in the case of “a grandparent who is older or in poor health, who may not be living when the grandchild is in college, prefunding a 529 plan makes sense. In those cases, I often recommend that the grandparent take advantage of the opportunity to make five years of contributions at one time.”

A grandparent with the means to do so may elect to “front-load” the 529 plan, by contributing up to five times the annual exclusion amount, ($70,000 individually or $140,000 per married couple), to a grandchild's 529 plan without facing gift or generation-skipping transfer tax consequences, provided that no additional gifts are made to the grandchild in that five-year period.

If a grandparent is not concerned with maintaining control of the gifted assets, another excellent - and in some ways superior - option is to contribute to a 529 plan opened by the child's parents, rather than to one opened by the grandparent. This option is generally preferable from a financial aid standpoint because distributions made from a grandparent-owned 529 plan during a grandchild's first years in college must be reported on the following year's federal student aid application as untaxed student income, whereas contributions made from a parent-owned 529 plan are reported as the parent's assets on the application. Alternatively, to minimize the negative impact on the grandchild's financial aid eligibility, the grandparent could wait to spend down the assets in a grandparent-owned 529 plan until the grandchild's junior year in college, when the last financial aid form has already been filed.

Grandparents with substantial assets who want to lessen the financial burden can also make direct tuition payments to the grandchild's educational institution. Payments for tuition made directly to an educational institution are not considered taxable gifts (though payments for room and board, books, or other fees are).

By making such direct payments, according to attorney Deborah Pechet Quinan of Boston-based Ruberto, Israel & Weiner, the grandparent is not only lowering the grandchild's tuition bills, but also “reserving the option of making annual exclusion gifts to the grandchild without incurring gift or generation-skipping transfer taxes."

A grandparent is, of course, free to gift money or other assets directly to a grandchild or to a trust for the grandchild's benefit, with the intent that such gifts be used primarily to fund college expenses, but unlike the options outlined above, such approaches may incur negative (and otherwise avoidable) tax and financial aid consequences.

Kimberly Clouse, Chief Client Advocate at Covestor, an online marketplace for investors.

DISCLAIMER: The information contained in this article is general in nature and not intended as specific advice. Neither Covestor nor its representatives are engaged in rendering tax or legal advice. A qualified professional should be consulted regarding the effect of such considerations on the matters covered in this contributed article.

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