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3 Ways to Help Grandkids With College Costs

As much as you love them, don’t use your retirement savings

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College isn’t cheap. In 2022-23, the average cost for tuition, books and room and board for full-time undergrads was $27,940 for in-state students attending a public college, according to the College Board. The cost ballooned to $45,240 for public school out-of-state students and $57,570 for those attending private colleges. If you have a grandchild heading off to college this fall, or your son or daughter just had a baby, you might be thinking of helping out to reduce the sticker shock.

Daniel McDonald, author of From Savvy Saver to Smart Spender: How to Pick a Tax-Wise Retirement Withdrawal Strategy, says that in the right financial situation, helping pay for college not only will bring you personal joy but will help alleviate the financial squeeze for loved ones and boost your grandkid’s odds of career success. It’s a way to highlight how important you think it is to earn a college degree. “It’s a great way to instill your values and (emphasize that) education is important,” says McDonald, creator of Retirement Tax Saver.

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But before you write a big check for tuition to Cornell or the University of Colorado, you must assess your finances to ensure you can really afford to help. “At your stage of life, you still could have 20 or 30 years left in your future, so you’re going to have to make sure your retirement is adequately funded,” McDonald says. “That’s a pretty important consideration.”

It’s a personal finance no-no to give away money earmarked for your retirement that could leave your nest egg underfunded. “If it’s going to derail your own retirement plans, it’s probably not a good idea and you should not do it,” says Judith Ward, a certified financial planner and thought leadership director at mutual fund firm T. Rowe Price.

If you do have the financial means to step in, here are ways you can help with college costs and pass on wealth in a tax-efficient manner.

Pay tuition costs directly to the college

If your granddaughter is graduating from high school this year and heading off to a college campus in the fall, a good way to help is to make a tuition payment directly to the college or university, says Keven DuComb, senior financial planning and estate specialist at Altfest Personal Wealth Management.

The upside to this payment approach is that the Internal Revenue Service doesn’t consider a direct tuition payment a taxable gift, so you won’t have to worry about the $17,000 annual federal gift tax exclusion ($34,000 for a married couple) for 2023.

“It doesn’t count as a gift, even if it’s a $150,000 check to Harvard for four years of tuition,” DuComb says. And you’re still able to give your grandkids a separate tax-free gift this year. You’ll also lower the value of your estate, which is a plus from a tax standpoint. (The downside, of course, is that you have less money).

Payments can only be made for tuition. Other costs — room and board, books, fees and equipment such as computers — don’t apply, DuComb says. Direct tuition payments could also reduce your grandchild’s financial aid from the college. It won’t hurt to check with the college to see how any financial assistance you supply will impact the student’s financial aid eligibility.

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Fund college costs via a 529 savings plan

Taking advantage of 529 college savings plans is another solid option. The benefit of contributing to a 529 with your grandchild as the beneficiary is that the money you contribute grows tax-free and the withdrawals for qualified educational expenses are also tax-free.

529s are investment accounts similar to 401(k)s in that you can direct your contributions to one of the plan’s investment portfolios and benefit from the appreciation of the assets over time. These 529 portfolios are broadly diversified and invest in a combination of stocks and bonds. You can invest in funds that own a bigger helping of stocks the longer the child is from college, and decrease their stock holdings as college approaches. You can make contributions in a lump sum or make regular deposits.

Since the biggest benefit of a 529 plan is seeing contributions grow in value over time, going the 529 route is better when your grandkid is young. The earlier you start funding the 529 the better, because you get more bang for your investment buck.

“Between the stock market appreciation and the compounding effects of having many years for your money to work, relatively modest amounts of money put into a 529 early in the child’s life can really build up a substantial amount of money to use for educational expenses by the time they graduate college,” McDonald says. “If you start early enough, you don’t have to put in as much money for the 529 to have a big impact.”

DuComb’s back-of-the-envelope calculation for contributing to a 529 plan and reaping the biggest benefit is to do so before your grandchild reaches high school. “Middle school is typically the cutoff,” DuComb says.

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Another plus of 529 plans is that the money can be used for tuition as well as fees, room and board, books and other supplies. Also, you, the grandparent, maintain control over the money in a 529. In the event of an unexpected major financial event, you can still use the money for your own purposes if necessary. If you do, though, you’ll have to pay a 10 percent penalty on the account’s earnings, as well as federal income taxes and possibly state or local tax. “It gives you a little bit of flexibility in case you need that money in the future,” McDonald says.

A coming change in the FAFSA (Free Application for Federal Student Aid) form can make it easier for grandparents to help fund their grandchildren’s higher education with a 529. Beginning in the 2024-25 award year (the revised FAFSA form will be available in December), distributions from a nonparent-owned 529 will no longer be counted as income to the student. Currently, the FAFSA counts 50 percent of student income toward the expected family contribution (EFC) calculation.

Grandparents can also choose to fund a large gift up front in a tax-friendly way. A 529 plan allows contributions equal to five years’ worth of gifts to a single beneficiary in a single year without triggering the federal gift tax. The maximum contribution eligible for the five-year election for individuals is $85,000 and $170,000 for married couples for 2023.

Write a check directly to your grandchild

Writing a check directly to your grandson or granddaughter to use to pay for college is another option. But it’s not one that most personal finance pros recommend.

One downside is you run the risk of your grandkid using the money for something other than tuition. As much as we love our grandchildren, trusting an 18-year-old with a large lump sum is probably not a risk you’re going to want to take, McDonald says. “I think you’ll want to keep a little control of where your money goes,” he says.

If you cut a check, you’ll want to make sure it’s for less than $17,000, or $34,000 for married couples, to avoid the gift tax. Writing a check directly to your grandson will be considered income to the potential student and, as noted above, will impact financial aid eligibility for the 2023-24 aid year. The new rules about cash support start with the 2024-25 aid year.

Experts say helping out with college costs isn’t just about tuition. You can also chip in by helping pay off debt your grandkid has from student loans, McDonald says. Knocking out loan debt enables your granddaughter or grandson to avoid high-interest expenses and the cash-flow-draining cost of monthly payments having an adverse impact on their financial aid. “They get the double benefit,” McDonald says. Since they’re out of school, there are no financial aid forms to fill out anymore. “By helping them pay for their student loans after they have graduated, you’re doing so without having an adverse effect on their ability to get the maximum financial aid that’s available to them,” McDonald says.

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