Helping with college costs is a generous things for grandparents to do.
Make sure you do it in the most cost-effective way
You can write a check directly to the college, and this does not count toward the tax-free gifts you can give each year. The limit is $14,000 to any individual, and another $14,000 for your spouse, for a total of $28,000. This means you and your spouse can give a grandchild $28,000 a year without any tax penalty, and you can also pay the full college tuition bills.
For the less affluent among us, the strategies get more complex. You don’t want to cut into any scholarship aid your grandchild may receive. Don’t give any financial gifts directly to your grandchild. If you give it the year before she starts college, it would be counted as income and will reduce any scholarship money she gets by as much as 50% of the gift.
If you give the money to her parents, it is counted as an asset of theirs, but the reduction in potential financial aid will be a much smaller.
How Assets are Calculated for Student Aid
Here is how assets are counted as being available for college costs, in figuring out potential financial aid, according to savingforcollege.com:
- “20% of a student’s assets (money, investments, business interests, and real estate)
- 50% of a student’s income (after certain allowances)
- 2.6%- 5.6% of a parent’s assets (money, investments, certain business interests, and real estate, based on a sliding income scale and after certain allowances)
- 22%-47% of a parent’s income (based on a sliding income scale and after certain allowances)”
A popular approach is to open a special college savings account, called a 529 account, in the name of your grandchild. Any money you deposit in the account grows tax-free. You can give as much as five years worth of tax-free gifts, $70,000, in a single year without any gift tax penalty. (But you can’t give anything for the next four years.)
Many states allow you to take a tax deduction if you put the money in a 529 account. The money grows tax-free, and the distributions to pay for college also are tax-free.
The saving for college website has a vast amount of information on 529 plans.
The 529 plans have different fees and charges. The Morningstar Investment firm tells you which ones look like the best deal in terms of costs and returns. But another way to look at things is from your viewpoint as a taxpayer as the owner of the accounts, and Morningstar also has some good advice here.
Bundling the Money for the Senior Year
Distributions from a grandparent’s 529 account to a student is counted as student income under the rules for financial aid. Students fill out a form for the following year to determine what financial aid they will receive. If the grandparent’s 529 is used just for the final year of college, the income rule won’t apply since the student isn’t seeking aid for the following year. So the best way to give money, without cutting down the chances of scholarship aid, is to use the 529 funds to pay for the senior year.
If you need the 529 money back, you can withdraw it at any time for any reason, and you will pay taxes on the amount you contributed, plus a 10% penalty on any profits earned.
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