It’s that time of year when high school juniors and seniors are spending weekends and winter breaks visiting college campuses throughout the country. They’re hoping these trips will answer dozens of questions — where will I fit in best, which school has the best program I’m interested in, which will accept me and, sometimes most important, how will our family pay for this?
As you watch your children and grandchildren go through the college admissions process, you’ll want to consult with your advisor for advice if you plan to help, financially or otherwise. In the meantime, here are five strategies to keep in mind.
1. Look for scholarships based on your affiliations
Your background may include organizations and institutions that offer scholarships specifically to children and grandchildren. As you begin the admissions and financial aid process, be sure to give your child/grandchild a full list of your affiliations, including past and present employers, unions, military service, memberships and hobbies, and any details concerning religion, race and ethnicity. You can use this list to search the various scholarship websites for a possible fit.
2. Give cash after the fact
It may seem counterintuitive to wait to give a cash gift to help pay for college, but a large sum given directly to your child/grandchild is treated as untaxed income and can affect financial aid eligibility, sometimes dramatically. If you wait until the child is a senior in college or has graduated from college, the gift won’t affect need-based aid anymore and can be used to help pay off student loans. An option for grandparents is to give the gift to your grandchild’s parents instead. Such gifts are reported as parental assets on financial aid applications and therefore will have a smaller effect on aid awards.
3. Cosign a loan
For grandparents, you can’t borrow from the federal PLUS loan program like parents can unless you have formally adopted your grandchild. But, you can cosign for a private student loan for your grandchild. This may help if your grandchild’s parents and your grandchild are already maxed out with college debt but still need to cover some costs. If you go this route, proceed with caution, especially if you are on a fixed income. If your grandchild defaults on the loan or is delinquent, the lender will come to you for repayment.
4. Pay tuition directly
You can reduce your estate tax and avoid a gift tax by paying the tuition bills directly. This is especially helpful if you have ways to utilize your annual gift exclusion other than college savings. (For 2014, you are allowed to give up to $14,000 without a gift tax being paid.) You can use any tuition payments beyond that limit to further reduce your taxable estate. Only tuition payments are eligible. You may not use payments for room, board or other education fees. Be aware, however, that some colleges will reduce a student’s financial aid by the amount of your payment. Before sending a check, ask the school how it will impact their financial aid.
5. Open a college savings plan
Many states offer at least one 529 college-savings account. In these plans, earnings grow tax-deferred and withdrawals are free from federal income tax if you use them for qualified education expenses. Contribution limits are usually quite generous and many states also offer tax incentives for 529 savings. It may be best to have the child’s parents be the 529 account owner. The reason: Distributions from a grandparent owned account used to pay for a grandchild’s education expenses are treated as student income on the subsequent year’s financial aid formula.
These accounts can be a good estate planning tool for grandparents. Individuals can make a lump sum gift of up to $70,000 ($140,000 for married couples) to a 529 and avoid a federal gift tax as long as they elect to have the gift treated as if it came in equal installments over a five-year period. No other gifts can be given to that beneficiary during those five years.
Coverdell Education Saving accounts are another tax-advantaged way to save for education costs. As with 529s, earnings grow tax-free, and qualified withdrawals are exempt from federal tax and often from state tax. You can use Coverdell funds for private school tuition for grades K through 12 as well as for college. Income restrictions apply, however, and contributions are limited to $2,000 a year.
Keep in mind that 529 and Coverdell contribution limits are per beneficiary, so parents and grandparents can’t set up an account in the same plan.