Before You Say Yes To The Grandparents' Paying For College, Read This

The Squeeze

• There are multiple smart ways your parents can save for their grandkids’ — your kids’! — college education, but first: Make sure they have saved enough to cover their own retirement needs. They can always give cash when your child reaches college age, but retirement savings are a must and need time to grow.
• Unlike a parent’s 529, a grandparent’s 529 is not factored into financial aid decisions. Bonus!
• A 529 isn’t the only option: “custodial accounts” are more flexible, meaning the funds don’t have to be spent on college if your child chooses a different path.

When it comes to paying for your children’s college education, smart parents want to consider all the options. And truly, what could be a better option than having someone else pay for it? 

We’re kidding — a little. Because the truth is, many grandparents want to support their grandkids’ education: a 2015 Massachusetts Educational Financing Authority study showed that 88 percent of grandparents would make contributions to college costs if asked to do so instead of giving traditional gifts. (Your 5-year-old may miss out on that XXL stuffed giraffe, but your 18-year-old will thank you.) So go ahead and ask! 

Here are smart strategies your parents can adopt to lend a hand, no matter how old your children are.

Best ways for grandparents to help pay for college

First, let’s get one thing straight: although your parents may really want to help with college, if they do not have sufficient secure retirement savings, then you should turn down their generous offer gently, and redirect their enthusiasm toward smaller — but no less helpful — supports such as buying your child a new laptop, or even just a year’s supply of Starbucks gift cards. 

College tuition may feel like a big-ticket item, but it’s nothing when compared to having to support your parents financially in their elder years. Retirement funds need years to grow, and your parents’ long-term stability is way more important for your total-family financial wellness than the short-term help of college funds. But if their retirement savings and finances are in a healthy place, then it’s never too early (or too late!) to have grandparents lend a hand.

Pros and Cons of Different Methods of Paying for College

There are multiple paths for grandparents to set aside funds for college. Which method is the right method depends on several factors, including your parents’ overall financial picture, when they are starting their savings plan, and how much they want to contribute. Popular options include:

1. Contributing directly to an existing 529 plan

If you or your spouse already created a 529 plan, the easiest move is to have grandparents contribute directly to it. That said, there are downsides: your parents won’t receive any tax-deductible benefits on their contributions (if your state 529 plan offers those deductions), and 529 plan funds that are held by a child’s parents are counted as assets when financial aid packages are calculated. 

2. Creating their own 529 plan

Any grandparent can set up their own 529 plan in your child’s name. By doing so, they will garner any tax-deductible benefits. There are more flexible rules for how much they can save: they can gift up to $15,000 per taxpayer, per grandkid, per year in a 529 plan. You can also “superfund” a 529 and gift up to $75,000 all at once under five-year gift-tax averaging rules — a great option if grandparents find themselves in a position to give generously right before or during your grandkid’s college career. (Tip: it’s a seamless way to reduce a taxable estate if you’re in a position to do so.) 

Keep in mind that a 529 account is not exclusively for college: up to $10,000 per year can be taken, tax-free, from a 529 plan to pay for K-12 education at a private institution. 

The downside: 529 plans are not transferable, although you can change the beneficiary without penalty. If your children do not attend college, your parents will have to pay a tax penalty on converting their account to cash.  

3. For small amounts, open a Coverdell education savings account (ESA)

A Coverdell account is another tax-free way to save for education, including qualified K-12 expenses. Unlike 529s, there’s a cap on how much can be put into a Coverdell ESA: $2,000 total from all sources. If the amount exceeds $2,000 (for example, if you put $2,000 in and your grandkid’s other grandma puts in $1,000) then your grandchild has to pay a penalty upon withdrawal. Also a potential downside: While a grandparent can set up a Coverdell for their grandkids, many banks require a child’s parent or guardian be the actual owner of the account. 

4. Consider a custodial account if you need more flexibility

Having your parents open a brokerage account on behalf of your grandchild can offer the most freedom in how your child uses the funds when they are old enough to access them. A custodial account can be opened through a bank, brokerage, or mutual fund company. These accounts are regulated by the Universal Gift to Minors Act (UGMA) or the Universal Transfer to Minors Act (UTMA), and the difference between these types of accounts are which assets can be placed under them: UTMAs allow for more types of assets, including real estate and art.

The money contributed to these types of accounts is exempt (up to $15,000 per year) from gift tax, and any money that the account earns is taxed at the tax rate of the minor who owns the account. The downside is once your grandchild is of age to access the money, the money is legally theirs, so neither you nor your parent have much, if any, say in how they use it. Also keep in mind that the money within an UGMA or UTMA account is considered an asset belonging to your child, and may reduce their eligibility for financial aid. 

5. Create a trust

The phrase “trust fund kid” makes it seem like trusts are exclusively for the incredibly wealthy, but that’s not the case. While a trust can require working with an estate attorney to set it up, a trust allows your parents to put in more guardrails as to how and when the money will be accessed. Trusts also have more flexibility in how the trust money is allocated: While many people set up a trust for each grandchild, you also have the option of creating a “pot trust” where the trustee of the account can distribute money to anyone in the family who asks, based on the trustee’s assessment of the request. The downside of creating a trust is that set-up costs can be prohibitive ($1,000 or more for estate attorney fees, plus paperwork) — and it’s nearly impossible to reclaim your assets once the trust has been established.

6. Pay tuition directly

Hey, not everything has to be planned in advance. Grandparents can always decide to simply pay tuition directly, by writing a check directly to the institution. This is a great option if your parents only recently cleared their goals for retirement savings and now know for sure they have a little extra to share. And the direct payment means everyone is exactly clear about where the money is going. 

Plan for college savings and estate planning together 

Because any kind of major financial gift your parents might be considering has long-term financial ramifications, it’s always good for them to consider the options with a financial advisor — and at the same time, help them take a long look at their money for both future use and for estate planning. It’s vital that your parents not shortchange their own needs based on their grandchildren. And an advisor can help them keep that in mind, as well as help them make small financial moves that go a long way. 

If your parents do plan to contribute to your children’s college education, it’s a good idea for them to keep the following in mind:

• Gift conservatively. Can they comfortably give to their grandchildren and afford living expenses for the next 20 to 30 years? Have you considered (and budgeted for) the likelihood of needing at least some long-term care? 
• Talk as a whole family. Most grandchildren have more than one grandparent family, with some even having as many as four sets. Consider scheduling a family meeting to discuss everyone’s plans, if they want to take part. Working together can help you all make fully informed financial decisions that can make paying for college as seamless (and tax-efficient) as possible.
• Know their grandkids. Your parents may assume they know exactly what your child plans to do with their life — and thus, may be surprised later that the 529 they’d been funding won’t be used by them. As your kids grow, you may want to keep your eye on whether there’s a need to pivot your parents’ strategy if one has their heart set on making a go of her singing career or another intends to pursue their no-higher-ed required path to startup stardom.
• Work with a finance pro. The pros can help you do financial modeling and run the numbers to let you know what you can and can’t afford, as well as the most tax-efficient ways for gifting.

Remember: little gifts add up. Birthdays, holidays, first day of school… consistent giving can and will turn into significant savings. So for many families, just having an organized plan for what to do with these annual gifts will be key to a successful long-term win.