With the cost of college continuing to rise, it’s important that students, parents and grandparents understand the options they have for tackling this significant expense.
Invest in a 529 Plan
State-sponsored education savings plans – known as 529 Plans – can be a great way for grandparents to help with college costs.
These plans offer tax-deferred growth on the dollars invested in the plan, and withdrawals for “approved higher education expenses” are tax-free.
The grandparent would be the account owner, and the student the account beneficiary. Note that it is possible for the grandparent to contribute to a 529 plan owned by the parent, as well.
These plans are flexible, in that any unused funds can be used for another grandchild or blood relative, simply by changing the beneficiary on the account.
Grandparents can pick any state’s plan, but because some states offer residents a tax deduction on contributions, it makes sense to compare your home state’s plan to other “best in class” plans.
Contributions to an account are considered “gifts” to the beneficiary for tax purposes. Grandparents can currently contribute as much as $15,000 a year (and $30,000 a year if they are married) per grandchild to a 529 account, without triggering any gift tax issues. And, it’s even possible to “bunch” up to 5 years of annual gifts into a single 529 contribution, which can be attractive to those who want to reduce the size of their taxable estate. As an example, married grandparents with four grandchildren could contribute as much as $600,000 in a single year ($15,000 per grandchild, times two grandparents, times four grandchildren, times five “bunched” years).
At Springwater, we currently recommend the Utah plan, because it offers a good investment menu, and relatively low fees and expenses. You can learn more about the Utah plan at https://my529.org.
There is one negative aspect of grandparent-owned 529 plans, if a family is hoping to receive need-based financial aid. Distributions will be counted as student income on the Free Application for Federal Student Aid (or “FAFSA”), and student income is weighed more heavily than parent income when determining aid eligibility.
Direct Payment to the School
Grandparents can write a check for tuition for any amount directly to a qualifying university or graduate school, with no gift tax consequences. This option can be attractive to those who would like to pay the university directly and also give the grandchild an additional $15,000 tax-free.
However, grandparents cannot claim a charitable deduction for tuition they pay on a grandchild’s behalf. Also, the exemption to the IRS’s gift tax rules applies only to payments for tuition expenses, and not other college-related expenses like room and board, books and supplies.
In addition, grandparents should be aware that this type of direct payment may impact the student’s ability to qualify for need-based financial aid.
Cash Value Life Insurance
A less common strategy involves the use of cash value life insurance to pay for college expenses.
The policy should be owned by the grandparent, with the grandchild as the insured, which makes the cost of insurance relatively inexpensive.
The grandparents can contribute after-tax dollars to the policy – in periodic monthly, quarterly or annual payments, or in a lump sum.
When the funds are used to pay for college expenses, they are considered a loan against the cash value of the policy. The withdrawals are tax-free at distribution, and they don’t count as income or assets on the student’s FAFSA.
This strategy would work best when the policy is purchased and funded before the grandchild is 8 years old. This because there is no cost to the grandparent to withdraw funds if the loans occur after the 10th anniversary of the policy. Withdrawals in the first 10 years will (typically) incur penalties.
The downside to this strategy is that the investments available may be more limited than those for a 529 plan, and the cost of the policy may be more expensive than more traditional savings vehicles.
Before considering life insurance as a savings vehicle, grandparents should take into consideration the type of insurance, the cost, and the expected return on the investment to determine its suitability.
Topic courtesy of the Wall Street Journal
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