Question: As a grandparent, I would like very much to help subsidize my grandchildren’s college expenses. What is the best way?
Answer: According to the College Board, 56% of the graduates from public four-year colleges in 2010 took student loans and graduated with an average debt of $12,300. The sticker cost of college tuition, books, room, and board rose 21% at California public four-year institutions last year. The average national annual cost for a public four-year college was $17,131 and for a private four-year college was $38,589.
You can help your grandchildren if they are already in college by paying some or all of their tuition and expenses directly to the school. In addition, you can give them cash. The amount you pay directly to the school will not count against the annual gift exclusion that allows you to give up to $13,000 ($26,000 from grandpa and grandma) per year without the requirement to file a gift tax return. (For 2013, the annual gift exclusion will increase to $14,000 per individual and $28,000 for married couples.) Your gifts and assistance may affect their ability to qualify for student aid. To avoid this, you could choose instead to wait until they graduate and then pay off their student loans.
If your grandkids are not in college yet, consider these options. Keep the money invested in your own accounts until they enter college and then do the above. Or gift them up to $13,000 each per year without filing a gift tax return and let them invest it. Another option is to form and fund a college savings trust with you or their parents as trustees and the kids as beneficiaries. A fourth option is to open a tax-advantaged college savings plan.
Keeping the money until they are in college might be your best choice if the kids are in high school now, especially if they are juniors or seniors. Their college funding is a short-term goal, the money should be invested accordingly, and money in your pocket won’t diminish their eligibility for financial aid. Paying the tuition and fees directly has the advantage of not counting as a gift for gift tax purposes. Gifting them $13,000 per year is often not the best choice, especially if they are under age 18 because you would have to gift the money to an UTMA, or Uniform Gift to Minors Account. The kids would be subject to the kiddie income tax rules, the money might reduce their eligibility for financial aid, the trustee could be tempted to spend the money for other purposes, and the kids would get free access to it at age 18 or 21 even if they were not in college.
Forming and funding a college savings trust is viable because you can keep control over the money and direct it to other purposes if the kids don’t go to college, but you have to hire an attorney to draft the trust documents, administer the trust, and pay tax at higher and less favorable trust rates.
Your fourth option, the college savings plan (aka 529 Plan), may be your best choice. You can easily set it up, you can maintain control over and manage the funds, you can change beneficiaries, the money grows in a tax deferred account, and withdrawals for qualified higher education expenses are tax-free.