A college education — even at a highly rated private institution — was once regarded as a relatively affordable route to lifelong prosperity, but in recent years it has become a hobbling financial burden for many families.
As a result, older generations are often stepping up to help their families with college funding. According to a Fidelity Investments survey of its investors — a more affluent group than the average — more than half of grandparents “are saving or plan to start saving to help pay for college costs.”
Sandra Schiff, who is retired and lives in Denver, has set up accounts for each of her eight grandchildren. She started funding the plans with her husband, Ronald. After running a successful wholesale plumbing business, they wanted to see their grandchildren graduate from college debt-free. At present, they have two recent graduates and two entering college.
“My husband and I didn’t go to college,” Schiff said. “But we heard about this opportunity to fund 529 plans and thought it would be wonderful for our grandchildren.”
The desire for one generation to help another with college has become more urgent in recent years. According to the College Board, private colleges averaged more than $40,000 in total expenses for the most recent academic year; state schools averaged around $17,000 for in-state students. More than 50 top-tier private colleges now charge more than $60,000 a year, including Columbia, Duke and Stanford.
One of the best vehicles for multigenerational college funding is a 529 college savings plan. Offered by states and managed by large mutual fund companies, these plans allow investment for future educational expenses, and the proceeds accumulate tax-free. Many states also provide a tax write-off for at least a portion of a contribution.
But there are some potholes to avoid for those who hope to maximize the value of their contributions and minimize the total cost for a family of sending a student to college.
Statistics are not available on the number of grandparents who have opened 529 plans. But it is clear they are widely popular. Today, they hold more than $250 billion in 12 million accounts, according to the College Savings Plans Network, an organization run by state treasurers. Last year, more than $25 billion poured into these plans.
Grandparents can set up these plans, naming grandchildren as beneficiaries. If the grandchildren decide not to go to college, the money can be kept in the accounts or used for another educational opportunity.
Since the children do not control the account — the owners do — the assets are not in their names. That means if grandparents need to withdraw the assets for themselves, they can do so, although they must pay a penalty and income taxes if the assets are not used for educational purposes.
While 529 plans are the prime vehicles of choice for many grandparents, they can complicate a child’s chances of qualifying for financial aid. The stumbling block comes when students receive money from the 529 plan. That will appear as income in the student’s name, which must be reported on the FAFSA, the form that most colleges require for financial aid when a student applies and every year he or she is in school.
To avoid a potential reduction in aid, grandparents could postpone sending 529 proceeds until the last two years of college, suggests Gary Carpenter, a Syracuse, New York-based certified public accountant and executive director of the National College Advocacy Group, a nonprofit focused on college financing.
“Distributions from grandparents’ 529 plans are seen as student income, and could reduce aid by 50 percent,” he said. That means if a grandparent takes $10,000 out of a 529 plan to send to a grandchild, it could cut student aid by $5,000 the following year.
“Postponing the distribution until junior year would be a good idea,” Carpenter said.
Giving to parents
Another strategy is for grandparents to give money directly to the parents. The reason it is important to avoid putting money in the students’ names in the early years of college is that 20 percent of a student’s assets are “assessed” in the federal formula, compared to only 5.64 percent of parental income and nonretirement assets. The more money that is in a child’s name, the more it pares back the aid package.
How does a grandparent know if a gift will impair a grandchild’s financial aid package? Most college websites have aid calculators, and the government’s aid calculator can be found at https://studentaid.ed.gov/sa/fafsa/estimate.
Although aid calculators provide ballpark estimates, a completed FAFSA provides applicants with the “expected family contribution,” the bottom line for the family’s total out-of-pocket expenses.
The expected family contribution is a number that colleges use after the need for financial aid — based on the income and assets of the parents and student — is determined. Some colleges, mostly private ones, also look at home equity. Under the federal aid formula, retirement accounts such as 401(k)s, IRAs and pensions are generally considered off limits for college funding.
Sending money directly to the grandchild could increase the family’s expected contribution. But the situation is much different if the family is unlikely to receive financial aid. Then, 529 proceeds and direct gifts from grandparents are possible options.
“Gifting may be a better strategy if the family won’t qualify for aid,” notes Fred Amrein, a fee-only financial planner in Wynnewood, Pennsylvania, who specializes in college planning. “Grandparents may want to pay college bills outright.” Under federal laws, couples can give up to $28,000 a year before facing gift taxes.
“Direct payment to the college for tuition is an allowable exception to the annual limit,” Amrein added. “This is only recommended if the family does not qualify for need-based financial aid.”
While direct giving is often a viable option for wealthy families, it will pay for someone fortunate enough to be in that situation to consider a more sophisticated financial planning strategy. Questions to consider include: Are estate issues a concern? Can securities be given to reap a tax advantage through stock or bond sales?
When planning a multigenerational strategy, a fee-only financial planner who understands college aid, estate and tax laws can provide useful advice. Planners can provide a number of strategies that mesh with a person’s estate planning, giving and portfolio objectives. These professionals can also discuss the best time to give.
Any certified financial planner with expertise in college planning can help form a strategy, or a certified college finance specialist can be found through the National Institute of Certified College Planners.
It is also helpful to check with a state’s 529 program first when considering a dedicated account. States have a number of investment options, including prepaid tuition plans for state and private colleges. Collegesavings.org and savingforcollege.com have thorough overviews of what each plan has to offer.
No matter which option is chosen for a grandchild, the parents will greatly appreciate the help.
“Grandparents have a natural inclination to spoil their grandchildren,” said Young Boozer III, state treasurer of Alabama and chairman of the College Savings Plans Network. “What better way to spoil them than with college savings? The gift will last much longer than a video game.”
Contributions to 529 plans can be made in lieu of cash gifts for birthdays, holidays, a confirmation or a bar or bat mitzvah. They can be some of the most meaningful gifts ever, but they should start early to build up savings.