Written by: Cheryl Winokur Munk |
Many grandparents are willing to help with college costs. One thing to keep in mind is that grandparent-owned 529s have a downside related to FAFSA, though there are workarounds.
There are several ways grandparents can help pay for a grandchildâs education without giving money directly to the student. Grandparents, parents, and students must understand each of the options before deciding which one may be appropriate for them.
For instance, they need to know whether the method theyâre using jeopardizes a studentâs prospects for need-based financial aid, or if it meshes well with the grandparentsâ overall estate plan.
Here is a look at three ways grandparents can help fund a grandchildâs education, and the pros and cons of each:
1. Invest in a â529â plan
Financial advisers often recommend the state-sponsored education-savings plans known as 529s to grandparents who want to help with college costs because of the many advantages this type of plan offers.
These plans, which invest mainly in mutual funds, offer tax-deferred growth on every dollar invested, and distributions are tax-free when used for qualified educational purposes. Grandparents can pick any stateâs 529 plan, and some states even offer residents a tax deduction on contributions. These plans also are flexible in that any unused funds can be transferred to another grandchild or blood relative.
Grandparents can put as much as $15,000 a year ($30,000 if they are married) per grandchild in a 529 plan without triggering gift-tax consequences. Even better, they can âbunchâ five years of annual $15,000 gifts into a 529 in one year without triggering a taxable event, a potentially attractive benefit for those seeking to reduce the size of their estates.
âTo me, the 529 is the turnkey solution for college planning,â says Jeff Motske, certified financial planner and president of Trilogy Financial, a financial planning firm in Huntington Beach, Calif.
Grandparents have the option of owning the 529 themselves or contributing to a 529 plan owned by the parent for the benefit of the child. One advantage of owning the account is that you âcan control where the money goes right up until the time itâs used,â says Jody DâAgostini, a certified financial planner with AXA Advisorsâ Falcon Financial Group in Morristown, N.J. Grandparents can even use the funds for themselves, albeit with tax consequences, should a financial need arise, she says.
INVESTING IN FUNDS
There is, however, a downside to grandparent-owned 529 plans for families seeking need-based financial aid: Distributions count as student income on the Free Application for Federal
Student Aid, or FAFSA, and student income is weighted much more heavily than parental income in the aid formula.
There are some potential workarounds, however. One option is to switch ownership of the 529 to the parent around the time the grandchild expects to start college. Not every stateâs 529 allows for a change in ownership, however, so this is something to explore before choosing a plan, Ms. DâAgostini says.
Another option is to wait until after Jan. 1 of the beneficiaryâs sophomore year in college to take a distribution, says Mark Kantrowitz, publisher and vice president of research at Savingforcollege.com. Since the FAFSA now asks for income and tax information from two years back, there would be no FAFSA on which to report the distribution if the student plans to graduate in four years. (If the student expects to graduate in five years, the family should wait until Jan. 1 of his or her junior year to take a distribution, Mr. Kantrowitz says.)
The grandparent also could roll over up to a yearâs worth of college expenses to a parentâs 529 plan after the FAFSA has been filed. Provided all of the funds are spent on qualified educational expenses, it wonât have to be reported on the next yearâs FAFSA, Mr. Kantrowitz says.
Some grandparents may not want the responsibility of owning the account, preferring instead to contribute a certain amount each year to a 529 plan owned by the parent for the childâs benefit. This may be appealing to those who want to give small amounts of money each yearâaround $1,000 or less.
In this scenario, âyour grandchild gets all the benefits without you having to worry about maintaining the account,â says Joseph Conroy, a certified financial planner and financial consultant with Synergy Financial Group, a wealth-management firm in Towson, Md.
The downside, of course, is the grandparent cedes control of the money to the parent.
2. Direct payment to an educational institution
Grandparents can write a tuition check for any amount directly to a qualifying college or graduate school without triggering gift-tax implications, says Eric Brotman, chief executive of BFG Financial Advisors, a financial planning and wealth-management firm in Timonium, Md.
Some grandparents like this option because they can pay the university directly and still give the grandchild an additional $15,000 tax-free.
Grandparents, however, canât claim a charitable distribution for tuition they pay on a grandchildâs behalf. Also, this exemption to the IRSâs gift-tax rules applies only to tuition expenses and not to other college-related expenses such as books and supplies. Another consideration is that the money isnât refundable if the student decides to switch schools, so it isnât advisable for grandparents to prepay tuition for all four years. Also, grandparents should be aware that this type of payment could have an impact on the studentâs eligibility for need-based financial aid.
3. Fixed-indexed universal-life insurance policy
Another, less-talked-about option for paying for collegeâalbeit a controversial oneâis using cash-value permanent life insurance.
One type that some advisers like is fixed-indexed universal-life insurance. Mike Windle, a partner, and financial adviser at C. Curtis Financial Group, a financial-planning firm in Plymouth, Mich., recommends this option because of the flexible premiums and upside potential without the downside risk.
To make this strategy work, the policy should be owned by the grandparent, with the grandchild as the insured, making the cost of insurance inexpensive, says Mr. Windle, who owns these types of policies and offers them to clients.
Having such a policy allows grandparents to contribute after-tax money in a lump sumâmonthly, quarterly or annually. When the funds are used, they are considered a loan against the cash value of the policy. They are tax-free at distribution, and they donât count as income or assets on the studentâs FAFSA, Mr. Windle says.
He generally recommends fixed-indexed universal-life insurance policies to clients whose grandchildren are 8 years old or younger. The policies he recommends have no cost to the grandparent to withdraw funds (and withdrawals arenât counted against the grandparentâs yearly gift-tax limit) if the loans from the policy occur in the 10th year of the policy or later, Mr. Windle says. If grandparents take a withdrawal before the 10th anniversary, it could cost them about 2% of the loan, depending on the insurance company, he says.
Though premium rates arenât guaranteed, Mr. Windle says the additional cost for a child would be minimal and is likely to be offset in part by growth in the policyâs cash value.
Another benefit is that the money can be used for multiple purposesâit isnât limited to education. And the policies have a death benefit if something happens to the child.
There are downsides to using life insurance as a vehicle for college savings, however, and not everyone thinks it is a good idea. An insurance policy can be pricier and the investment selections more limited than with some other options grandparents have for funding college, financial experts say.
Before purchasing a life insurance policy for college-savings purposes, grandparents should consider the type of insurance and return on investment, as well as applicable costs, to ensure itâs the best option for their situation.
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