By Matthew Gaude & Shawn McGuire
College is an important part of your grandchild’s future, and for many, paying for it will be a challenge. Today, the projected cost of a bachelor’s degree at a public college or university is $84,736; at private schools, almost $150,000. (1)
There are a lot of ways for grandparents to give grandchildren a head start on college—the problem is some of them may hurt more than they help. Here’s a guide to paying for your grandchild’s education, and the traps you need to watch out for.
Financial Aid: The Basics
Financial aid takes many forms: loans, grants, work study programs, scholarships, state programs, and assistance directly from colleges and universities. Eligibility for most of these programs is based on a standard financial need profile called the Free Application for Federal Student Aid (FAFSA). (2)
The FAFSA application identifies a family’s or individual’s assets and income, and calculates the EFC (expected family contribution). Financial aid from the federal government, state, and other sources is based on the difference between the anticipated cost of education, and the expected contribution.
Some assets on FAFSA count more toward expected contribution than others. Parental income and assets count less, while student assets and income count more. The more assets and income that are available on the FAFSA form, the higher the EFC. A higher EFC means a lower amount of aid. Your assets as a grandparent don’t appear on FAFSA unless your grandchild is a dependent. (3)
Annual tax-free gifts are generally limited to $15,000 per person. Grandparents can gift $15,000 each to a grandchild for a total of $30,000. You can, however, gift an unlimited amount of money to your grandchild for tuition provided it’s paid directly to the college or university. (4)
529 plans are tax-favored investment accounts that are set up for education savings. The person who opens the account is the account holder, and the person the account is for is the beneficiary. Sponsored by each state government, there are two types of 529 plans:
- Prepaid tuition plans purchase credits toward future tuition at a participating college or university. The credits are only for tuition, not for future room and board.
- Education savings plans can be used for tuition, fees, and room and board at any college or university. Account owners select investment options from a menu offered by the plan. Each state sets its own contribution limits to their 529 plans, however, most are in excess of $250,000 per beneficiary. Earnings accumulate and can be withdrawn federal income tax-free provided they are used for tuition or other qualifying educational purposes. 529 contributions are tax deductible in some states. (5)
Coverdell plans are individual trust or custodial accounts that are set up solely for paying the education expenses of the beneficiary. No more than $2,000 per year can be contributed into Coverdell accounts per beneficiary. Taxpayers with modified adjusted gross income above $220,000 on a joint return are not eligible for Coverdell accounts. Earnings accumulate and are distributed tax-free providing they are used for qualified education expenses, including elementary and secondary schools. (6)
Education Tax Exclusion
The interest on certain U.S. savings bonds is excluded from income if it is used to pay qualified education expenses. The exclusion is reduced at $123,550 of joint income and eliminated at $153,550. (7)
Grandparents Helping to Pay for College? A FAFSA Change You Need to Know
There are some upcoming changes to the Free Application for Federal Student Aid. Today I want to highlight a change that can impact clients who are grandparents.
One of the upcoming FAFSA changes will make it easier for grandparents, aunts and uncles, godparents and anyone else outside the nuclear family to help with college costs without hurting eligibility for financial aid. Before explaining the change, it’s important to understand what the situation is right now.
Currently, parents are supposed to share on the FAFSA if grandparents, aunts and uncles, godparents, friends or others outside the immediate family have kicked in money to pay for college costs. This financial assistance is considered the child’s untaxed income.
The FAFSA assesses a child’s untaxed income at up to 50%, which is a steep price.
The FAFSA has never penalized a student if grandparents or others have simply saved for a child’s future college years. Instead it has only been an issue when outsiders pulled money out and paid for college expenses.
New Way the FAFSA Treats Outside Help
The new FAFSA overhaul will not consider whether grandparents or other well-wishers have helped defray college costs. The FAFSA will stop asking this question starting with the application for the 2023–2024 school year.
This change might seem like a long way off, but it’s impact will actually be felt this year. That’s because the FAFSA depends on two-year (prior-prior) tax information. The 2023–2024 FAFSA can be filled out as early as Oct. 1, 2022 and will depend largely on information from 2021. And the 2023–2024 FAFSA, which normally would want to know about college payments from grandparents, will no longer ask the question.
What this means is that grandparents and other outsiders who help out with college costs in 2021 will not hurt aid chances via the FAFSA. In reality, grandparent help in 2020 was the last year that this assistance would need to be reported. Grandparent help in 2020 will need to be reported on the 2022–2023 FAFSA, which will be available beginning Oct. 1, 2021.
The federal government is removing the question about outside help with college costs as part of its move to simplify the federal financial aid application. As part of the makeover, the government got rid of some questions that few people answered including this one.
Now the Bad News…
While the FAFSA eliminated the question about outside financial help, the CSS Profile, at least at this point, is not changing its policy. It will continue to ask about outside assistance.
Roughly 200 colleges and universities, nearly all private, use the CSS Profile to determine how much institutional aid a student should get. These schools only use the FAFSA to determine state and federal aid.
While relatively few institutions use the CSS Profile, these schools include the most desirable private colleges and universities. Within the ranks of these schools are those that dispense the best need-based financial aid.
Unfortunately, the welcome FAFSA change will not be a consolation to families interested in Profile institutions.
Parents, whose children will be applying to Profile schools, will have to continue to take steps necessary to avoid outside help jeopardizing need-based aid chances.
Here is a sure-fire strategy to do just that:
Because parents are using two-year-old tax information, grandparents can safely start helping with college costs at Profile schools in the second semester of the child’s sophomore year after the family has filed for financial aid for the upcoming junior year.
You’ll want to consider two main questions when paying for your grandchild’s education.
1. How Will the Gift or Payment Affect Financial Aid?
If your child and grandchild are eligible for financial aid, a direct gift to your grandchild or a tuition payment will count 100% on the FAFSA as their income, which will have a bigger impact on the EFC. Distributions from a 529 plan owned by you will count as your grandchild’s income as well. On the other hand, a gift to your child or 529 owned by your child will have a lower impact on the EFC. (8)
2. How Will the Money Be Used?
If you have concerns about how the money will be used, or want to control the distributions, direct payment of tuition, owning the 529, or other other options like a trust may be a better solution.
Contribute Your Experience
The network and affiliations that you have built over a lifetime are potentially a source of scholarship money for your grandchild. For example, the Marine Corp League Foundation and Navy League foundation offer scholarships for children and grandchildren of veterans. Local chapters of service organizations like Rotary, Lions, and others often have scholarships available for children and grandchildren of members.
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Matthew Gaude is an *investment advisor representative and the co-founder of Live Oak Wealth Management, a financial services firm in Roswell, Georgia. He serves the planning and investment needs of corporate employees, those approaching or in retirement, and 401(k) plan sponsors. Working first as a commodity broker and then as a Business Development Manager for a national broker-dealer in previous jobs, he has the insight and experience to help clients understand the complexities of the market and implement strategies to minimize risk. To learn more about Matthew, connect with him on LinkedIn or visit www.liveoakwm.com.
Shawn McGuire is a financial advisor and the co-founder of Live Oak Wealth Management, a financial services firm in Roswell, Georgia. He serves the planning and investment needs of corporate employees, those approaching or in retirement, and 401(k) plan sponsors. He has worked in financial services since 2002 in positions ranging from financial advisor to stock broker and portfolio manager. As a CERTIFIED FINANCIAL PLANNER™ professional, he is trained to help clients with virtually all their financial needs. To learn more about Shawn, connect with him on LinkedIn or visit www.liveoakwm.com.
Securities offered through American Portfolios Financial Services, Inc., member FINRA/SIPC. Investment advisory services offered through *American Portfolio Advisors, Inc., a SEC Registered Investment Advisor. Live Oak Wealth Management, LLC is independently owned and not affiliated with APFS or APA.
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