Retirement Planning
May 24, 2017

College Planning for Grandparents | Baird Retirement Management

For most, juggling between saving for retirement and saving for their children’s college educations is a delicate balancing act.  The cost of college tuition is high and continues to grow at a startling rate.  As of this writing, research shows that the average cost of tuition and fees for the 2016–2017 school year was $33,480 at private colleges, $9,650 for state residents at public colleges, and $24,930 for out-of-state residents attending public universities. According to College Board, between the years of 2006-2007 and 2016-2017, in state tuition increased at an average rate of 3.5% and 2.4% per yer beyond inflation for public and private four year institutions respectively.

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Figure 1: Average Annual Percentage Increase in Inflation-Adjusted Published Prices by Decade, 1986-87 to 2016-17

For those retirees in the fortunate position of having enough to cover their retirement years and still have something left over to help other family members pay for college, it is important to know all of the available options and rules surrounding planning for college.  The key to most savings plans is to start early and contribute often.  In the case of grandparents setting aside funds for their grandchildren, often times the assets are available, but making sure those assets are transferred to the intended beneficiary in the right way is where the true challenge comes.

Early Stage Planning

If the grandchildren are younger and there is time to accumulate assets, a 529 savings account is a great option. 529s allow large contributions that grow tax-free and the distributions are not taxed when the money is taken out to pay for college.  Each year you can deposit up to the annual gift tax exclusion (hyperlink to Gifting Techniques PDF) amount per beneficiary ($14,000 single/ $28,000 married filing jointly) or up to 5 years up front ($70,000 single/ $140,000 married filing jointly) as long as no other contributions are made for that grandchild for another 5 years.  

For estate planning purposes, the value of the 529 account is removed from your taxable estate, yet you retain full control over the account including the right to ask for the money back at any time. No other savings vehicle affords this combination of control and estate reduction. Unlike custodial accounts (UGMA/UTMA) the 529 beneficiary has no legal rights to the funds which helps guarantee that the money will be used for its intended purpose. 

However, if for whatever reason the funds need to be withdrawn and not used for qualified higher education expenses the earnings are taxed at ordinary income rates and an additional 10% penalty is charged. If the grandchild decides not to go to college, the beneficiary on the account can be changed to another member of the current beneficiary’s family without any gift tax implications. Finally, for grandchildren who receive scholarships or attend a U.S. Military academy, the 10% penalty is waived for their non-qualified distributions.

Late Stage Planning

If the grandchildren are older and there is less time to accumulate savings there are other options to help cover costs.  As previously mentioned the annual gift tax exclusion amount per beneficiary is ($14,000 single/ $28,000 married filing jointly).  Under a special tax code exemption, if tuition payments are made directly to the institution the amounts paid are not subject to gift tax.  (Note: this exclusion only applies to tuition and does not include books, supplies, or room and board.) 

Another option would be to gift appreciated assets to the grandchildren directly and have these assets sold at their lower tax bracket, then using this money to pay for expenses.  The issue with this strategy is you have to watch the “kiddie tax” implications. The “kiddie tax” applies to unearned income for children under the age of 19 and college students under the age of 24. For 2017, the threshold for the “kiddie tax” - the amount of unearned net income that a child can take home without paying any federal income tax - is $1,050. All unearned income in excess of $2,100 is taxed at the parent’s tax rate. 

Finally, you could also have the grandchild apply for financial aid and take loans and then pay off the loans after they graduate.  This would help your grandchild establish a credit history, incentivize them to graduate, and allow them to deduct student loan interest on their tax return until the loans are paid in full.  However, this option comes with the caveat of the loan payments being considered gifts to the grandchild. So, if you were to only pay up to the annual gift exclusion amount each year it could take a few years to pay the loans off completely at current tuition rates.

The planning strategies offered in this article do not take into consideration all of the effects that a grandparent’s gifting can have on the grandchild’s financial aid eligibility. This list of options is not all inclusive or exhaustive.  One or a combination of strategies above may be appropriate for your situation.  With all financial decisions it is helpful to consult with a financial advisor and qualified tax expert before putting a plan together.

Investors should consider the investment objectives, risks, charges and expenses associated with a 529 Plan before investing. This and other information is available in a Plan’s official statement. The official statement should be read carefully before investing.

Depending on your state of residence, there may be an in-state plan that provides tax and other benefits not available through an out-of-state plan. Robert W. Baird & Co. does not provide tax advice. Before investing in any state’s 529 plan you should consult your tax.

For college cost and 529 calculators, as well as other helpful college planning resources please click here.

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