As college costs continue to rise, one of the best ways grandparents can help their grandchildren get ahead in life is helping pay for higher education. Grandparents can find great satisfaction in passing on wealth in a way that has great impact and allows them to avoid gift or estate taxes. Without the weight of student loan debt, young people can allocate their finances to building their lives – purchasing homes, chasing dreams and building families.
If you’re considering paying for a grandchild’s college education, here’s what you should consider.
Will Paying for My Grandchild’s Education Affect Their Financial Aid?
A student’s eligibility for financial aid is based on income and assets held by the student and their parents as reported on the Free Application for Federal Student Aid (FAFSA). These pieces of information, along with additional factors, go into a formula to calculate the Student Aid Index (SAI). This is a change from pre-2023 calculations using the Expected Family Contribution (EFC).
- Parental income is calculated based on income minus allowances for nondiscretionary expenses, such as taxes and living expenses. The rest is considered discretionary and available to help pay for education. In the past, 22%-47% of parental income was used in college funding calculations.*
- Parental assets, including cash, trust funds and 529 accounts are considered low-impact assets. Historically, only up to 5.64% of the value of these assets were used in calculating financial need.*
- Student income from jobs and from gifts (such as distributions from a grandparent’s 529 plan) is added to the SAI calculation; previously, this has been added at a 50% rate.*
- Student assets, including UTMA/UGMA accounts, are considered high-impact assets. In the past, aid calculations have included up to 20% of the value of these assets.*
So ultimately, how a grandparent choose to provide money for their grandchildren’s education can impact the student’s eligibility for financial aid.
Can I Get a Tax Deduction for Funding My Grandchild’s Education?
The American Opportunity Tax Credit (AOTC) is a credit for qualified education expenses paid during a qualifying student’s first four years of higher education (maximum of $2,500 per student). The Lifetime Learning Credit (LLC) is a credit of up to $2,000 per tax return for any post-secondary education and courses to acquire or improve job skills. Grandparents with modified adjusted gross income (MAGI) of less than $80,000 ($160,000 if filing jointly) who claim the student as a dependent may be eligible to receive a tax deduction for t heir grandchildren’s education.
While contributions to a 529 plan are not deductible on federal taxes, over 30 states offer a tax deduction or credit for contributions to 529 plans.
Are College Tuition Payments Subject to Gift Tax?
The federal government has set a threshold for financial gifts, above which the giver must pay gift tax. In 2023, the limit on tax-free gifted money is $17,000 per individual giver to each recipient (note: in 2026, this is expected to drop). Tax rates range from 18% to 40% depending on the gift amount. The method in which grandparents choose to provide funds for education expenses impacts whether or not this applies; for example, tuition paid directly to the school is not subject to gift tax.
Best Ways for Grandparents to Pay for College Expenses
Grandparents wishing to support their grandchildren’s education have a few options for how to do so. Here are the best ways for grandparents to give money to their grandchildren for education.
Make an Outright Cash Gift
Although an outright gift of cash may be an easy option, it has a few drawbacks. All cash gifts are subject to the annual federal gift tax exclusion, meaning gifts above $17,000 from individuals ($34,000 from couples) in 2023 might have gift tax and generation-skipping transfer (GST) tax consequences. Avoiding these taxes by giving an amount below that threshold may not be enough to cover everything the grandchild needs. Additionally, cash given to a student will be considered untaxed income by the FAFSA – historically, this pool of money has been assessed at a rate of 50%, which can impact the child’s financial aid eligibility.
A cash gift to a parent would not need to be reported as untaxed income on the FAFSA, so that avoids the financial aid eligibility question, as well as the GST tax consequences, though it would still be subject to the gift tax threshold and would count as a gift to the parents.
Pay Tuition Directly to the School
Tuition payments made directly to universities and colleges aren’t considered taxable gifts, regardless of amount. However, that is only the case for tuition – room and board, books, fees, equipment and other costs do not qualify. Because tuition isn’t considered a gift, grandparents can pay tuition directly to the school and provide cash directly to their grandchildren for other expenses.
The downside of this method is that colleges will often reduce financial aid by the amount of the direct payment, thus impacting the scholarship or grant money the student receives.
Contribute to a 529 Plan
529 plans are a great savings vehicle for education expenses. Contributions to a 529 plan grow tax-deferred, and withdrawals for qualified education expenses are tax-free at the federal level (and typically the state level, as well). A major benefit of using a 529 plan is that individuals can make lump-sum gifts of up to $85,000 ($170,000 for a married couple) and treat the contribution as if its spread over five years to avoid federal gift tax. There are two ways grandparents can contribute to 529 plans:
Contributing to a Parent-Owned Plan
Anyone can contribute to a 529 plan, regardless of the owner, and 529 plans have very high lifetime contribution limits, though the exact amount varies by state. Because parent assets are treated as low-impact assets when considering the expected family contribution, funds in parent-owned 529 plans will be significant help to your grandchild, though you may not receive the state tax benefits.
Opening a Plan in Your Name
With the current FAFSA, distributions made from a 529 plan in a grandparent’s name to the student count as student income, meaning it can impact their financial aid eligibility. It’s best to keep this money in a 529 until after January 1 of the student’s sophomore year (if they anticipate graduating in 4 years) so it won’t count on future FAFSAs, which use previous year’s tax records. There are plans for this to change moving forward, making it easier to help with grandchildren’s college expenses.
Set Up a Trust for Education
An education trust gives the owner of the trust the highest level of control over the money as compared to the other options. The trustees will be legally obligated to fulfill the creator’s wishes for access to the funds. If the education trust is irrevocable, it’s also protected from creditors. There may also be some tax benefits to gifting money in a trust. However, the downsides of opening a college fund for grandchildren through a trust include the fees to set up/oversee the trust and the rigid structure of a trust. Education trusts are also counted as an asset of the child, meaning they have a significant impact on financial aid eligibility.
Pay Off Their Student Loans After Graduation
If your primary concern is your grandchild’s student aid eligibility, you may consider waiting to pay off their student loans after they graduate. This can help incentivize them to finish school and they maybe able to claim a tax deduction for student loan interest. However, this is still considered a financial gift so subject to gift tax rules for amounts above $17,000 per individual. When average borrowing ranges from $33,700 to $49,700, according to Educationdata.org, the gift tax threshold may restrict how much grandparents are able to help.
Start a Conversation
If you’re interested in helping fund higher education for the next generation, talk to a Farm Bureau Financial Advisor. They are able to work with other professionals – such as a CPA and an attorney – to create a plan that best fits your situation.