College Savings Information
for Grandparents

With college costs rising every year, parents can use all the financial help they can get, and that help often comes from Grandma or Grandpa. Grandparents want their grandchildren to receive the best education possible, and they often have the resources to help.

If action is taken early enough grandparents can reduce, or even eliminate, a grandchild’s reliance on loans and grants by the time they reach college.

Make a Gift

One of the most common ways grandparents help with college savings is to make an outright gift of cash to the grandchild. Each grandparent can give up to $12,000 per grandchild each year ($24,000 a year per grandchild if both grandparents contribute). This amount is free of estate taxes or gift taxes. While this is certainly the easiest way to help pay for college, it is not necessarily the best, and outright gifts can have some disadvantages.

First, the gift may not be enough to cover a grandchild's education expenses and giving more than $12,000 a year will trigger gift taxes.

Second, if the gift is made directly to the grandchild, instead of the parents, the money will be treated as the student's assets which can significantly reduce eligibility for financial aid.

Finally, there's the very critical issue of who controls the money. Because the money now belongs to the grandchild, the grandparents do not necessarily control how the funds are spent. It is quite possible for the grandchild to spend the money on a sports car rather than college tuition.

Pay the Tuition

One way grandparents can ensure that their gift is used as intended is to pay for tuition directly. One advantage of doing this is that direct tuition payments aren’t considered gifts because they qualify as gift-tax exclusions (IRC section 2503c). This means that, regardless of the tuition amount, there aren't any gift-tax issues to worry about, even if the amount is over the annual exclusion of $12,000. It also means you are still free to give a tax-free gift up to the annual $12,000 limit.

However, a direct tuition payment can also reduce a student's eligibility for financial aid because such payments are treated as part of the student’s financial resources. Additionally, only tuition payments are covered under the gift-tax exclusion. Direct payment of room and board, books or other expenses counts toward the annual gift allowance of $12,000.

A Favorable Alternative: the 529 College Savings Plan

Another option is the 529 college savings plan. These accounts allow grandparents to maintain control over the funds. Contributions to 529 plans grow tax-free. There are no federal income taxes on earnings if the money is used to pay for education expenses.

If the grandchild decides not to attend college, the account's beneficiary can be easily changed. Finally, if the money is needed for some other purpose, it can be withdrawn. However, experts discourage withdrawing funds for non-educational expenses because the account's earnings will be taxed at the owner’s ordinary income rate, plus a 10 percent penalty.

Contributions to a 529 plan also qualify for the annual federal gift tax exclusion. This means that a grandparent can contribute up to $12,000 a year to the account ($24,000 for married couples). There is also a special gift tax exclusion for 529 accounts that enables the owner to make five years’ worth of gifts (up to $60,000) in a single year ($120,000 for married couples) without paying federal gift taxes. This special gift can be used every five years.

From a financial aid standpoint, a 529 account is much better than a Uniform Gifts to Minors Act (UGMA) or Uniform Transfers to Minors Act account (UTMA). Funds in a UGMA or UTMA transfer to the child when the child reaches legal age and will affect their financial aid eligibility.

The advantage of a grandparent-owned 529 account is that funds are not included in determining a student's financial aid eligibility, unless the grandparent claims the child as a dependent on an income tax return.

One Final Thought

If you are a grandparent and plan to apply for Medicaid benefits, you should be aware that owning a 529 plan may jeopardize your Medicaid eligibility.

Because 529 plans allow account holders to withdraw money, some states consider the funds in those accounts accessible for nursing home and other medical expenses.

This potential concern is one reason grandparents may want to consider contributing to an already existing 529 account that is in the name of the grandchild's parent instead of creating their own. 

Therefore, grandparents should ask their children if they have a 529 plan already open for a grandchild and how to contribute to it.