413-781-2820 413-781-2820

How Can You Help Pay for Grandchild’s Education?

As soon as a child is born, a parent may begin to worry about college and other education costs. Grandparents often are eager to help ensure that their grandchildren have the best educational opportunities possible. What are the various options available for making gifts for education?

529 College Savings Account: Perhaps the best-known option, this type of account is established with a broker or with a state plan. Only cash contributions are accepted, but anyone can be a donor – there are no income limits. The account grows federal income tax-free; qualified distributions are free from federal income tax as well. Donors can front-load with up to five years of annual exclusion gifts (or, in 2015, $14,000 x 5 = $70,000). As long as the student attends a qualified institution of higher education, funds can be used for a broad range of post-secondary costs, including tuition, fees, room and board and expenses of special needs services. The donor must designate the beneficiary, but the beneficiary may be changed to another family member. If the 529 Account is owned by the parent or student, it counts as an asset of the student for financial aid, but distributions do not affect eligibility. If it is owned by the grandparent, it does not count as asset of the student, but distributions count as income to the student for financial aid purposes.

529 Prepaid Tuition Plan: Also well-known, a prepaid tuition plan is established with a participating state or a private institution consortium. As with 529 College Savings Accounts, only cash contributions are accepted. The account grows federal income tax-free and distributions for college tuition are exempt from federal income taxes. Donors can front-load with up to five years of annual exclusion gifts (or, in 2015, $14,000 x 5 = $70,000). As the name suggests, the donor is pre-paying tuition for the student. Current tuition rates are locked in for the future. Programs vary from state to state. The donor must designate the beneficiary, but the beneficiary may be changed to another family member. If owned by the parent or student, it counts as an asset of the student for financial aid, but distributions do not affect eligibility. If owned by the grandparent, it does not count as asset of student, but distributions count as income to the student for financial aid purposes.

UTMA/UGMA Account: These Uniform Transfers/Gifts to Minors Act accounts are established by the donor naming a custodian for the benefit of a minor. They can be opened as a brokerage or bank account and assets other than cash may be used, depending on the institution. The account is deemed as owned by the minor, but is controlled by the custodian. Income is generally taxed at minor’s rate, unless the so-called “Kiddie tax” applies. Gifts to UTMA/UGMA accounts qualify as annual exclusion gifts ($14,000 in 2015) but donors are not limited to that amount; larger amounts will require gift tax reporting. Funds can be used for any purpose relating to the minor, and are not restricted to educational expenses. Assets in an UTMA/UGMA account count as an asset of the student for financial aid.

Direct Payment to Institution: Unlimited gifts in the form of tuition paid directly to the educational organization and are permitted under the federal tax code without being subject to gift tax or gift tax reporting. Under this provision, only tuition may be paid and the payment must be directly to the institution. Private schools at any level, unaccredited schools and foreign educational schools and universities qualify. Such gifts will probably be treated as a resource of the student for financial aid purposes.

Coverdell Education Savings Account: In order to establish one of these accounts, the donor’s adjusted gross income must be below limits set by IRS ($110,000 individual/$220,000 couple). Annual contributions cannot exceed $2,000 per beneficiary. The account grows federal income tax-free; qualified distributions are free from federal income tax as well. Withdrawals can be made for higher education, as well as elementary and secondary educational expenses. Eligible expenses include tuition, fees, books, supplies and equipment, room and board, as well as expenses for special needs services. In addition expenditures can be made for computer technology or internet access for elementary and secondary school students. An account may be opened at any bank or entity that offers Coverdell ESAs, and can be established for any beneficiary under age 18 or who has special needs. Contributions cannot be made after beneficiary reaches age 18 unless the beneficiary has special needs. Assets are counted for financial aid purposes.

Trust for Benefit of Student: Various types of trusts can be created for the benefit of one or more children and offer great flexibility. Funds can be used for purposes defined by the donor, and any type of asset can be used to fund the trust. The trust terminates when specified by the donor. The trusts are subject to income tax and the should be mindful of the annual exclusion limit when contributing to the trust and the need to file gift tax returns if contributions exceed the annual exclusion limit. Most trusts, but not all, are treated as a resource of the student for financial aid.

Sometimes a combination of these tools can offer the best results. The rules relating to these programs can be tricky, and you should consult with a professional advisor when considering which of these techniques is best for you