You have a grandchild—congratulations! Whether you’re a new grandparent or have been one for years, you probably think about the ways you can help them succeed in the future. Sure, their parents are probably taking care of so much of that, but they also have many other expenses to take into consideration. Between bank fees, insurance, mortgages, etc. your children are knee deep in financial responsibilities on top of the expenses of having their kids. Because of this reality, many grandparents decide to help their grandchildren avoid the burden of student loans by contributing to their tuition costs.
There are several options to save or pay for your grandchild’s education. You can use bonds, interest incurring savings account, or a 529 plan.
529 Plan – Ever heard of it?
This is a college savings plans that offers tax and financial aid benefits. You invest by state and can choose any state, not just the one you reside in. Most states have a plan, though the details will vary state-to-state. This plan is similar to a ROTH 401(k) or ROTH IRA because you invest post-tax. These funds can also be used to fund K-12 schooling.
BENEFITS
There are many perks to this plan. The most compelling is the tax breaks. While the contributions are not federally tax-deductible, many states offer tax deductions for 529 plan contributions. Even better, qualified distributions, such as tuition, books, school supplies, are tax-free! This can be much more economically wise because many traditional savings vehicles such as CDs and bonds incur taxes, even if used for education.
Another perk is that growth on your investment in a 529 plan is completely tax-free! More money for education means less stress and more focus on studying. The best part of this plan? You don’t have to report it on your federal taxes until you withdraw! If the withdrawal is less than $15,000 per person ($30,000 for married couples filing jointly), it will qualify for the gift tax exclusion.
Aside from the many tax breaks this plan offers, it’s also low maintenance because of the ‘set it and forget it’ option to auto-invest by linking to your paycheck or bank account. The management of the account is controlled by an outside investment company, meaning you won’t have to worry about maintaining your account. Want to change your investment options? You can do that twice per calendar year under this plan.
DRAWBACKS
Of course, as with many good things, there are some downsides. Just like most investment plans, the 529 comes with fees. Depending on the investment you choose, there could be high management fees. Along with those fees, there is a penalty for non-qualified withdrawals, mainly educational.
In addition to the penalty, the child may have issues with financial aid eligibility. FAFSA calculates the student’s Expected Family Contribution (EFC) and determines the grants and subsidized loans offered. The bigger the EFC the less they give. There are limited investment options with this plan. Depending on the plan, you may not be able to diversify it how you’d like. Some plans only offer specific funds and have auto-allocations based on the beneficiary’s age.
Gifting Cash
If a 529 plan isn’t your style, you can gift cash. The current gift-tax exclusion is $15,000 per grandparent, so grandparents can give combined $30,000 per year to their grandchild without paying tax. There is an exception that allows grandparents to gift 5 years’ worth of gifts at once. You’ll have to skip gifting for the next 5 years, but this could be an alternative to a 529 if you have the funds.
BENEFITS
The cash can be taken from any investment plan, such as one that may be more suitable for your goals or more profitable. Depending on where the money comes from, there could be fewer fees involved. Every situation is unique, but in some cases, the student may not have to report it to FAFSA for financial aid.
DISADVANTAGES
Gifting cash is taxable if over $15,000. However, depending on where you pull the cash from, it may not qualify. If this comes from a tax-deferred retirement account, then the $15,000 may not count towards your RMD. If you want it to satisfy this requirement, you’ll have to pay taxes on the distribution. The cash may not be as low maintenance as a 529 plan. The growth on your tax, if it accumulates any, may not be tax-free like the 529 plan.
Another perk of the 529 that cash gifting doesn’t have is tuition lock. Some plans offer a prepaid tuition path that averages the current cost of four-year in-state public colleges. The beneficiary is guaranteed this rate even if it goes up drastically by the time they’re in college. While we won’t know what college pricing will look like in the future, based on history and inflation, we can bank on it continuing to rise. Finally, if the student isn’t going to college for a few years, are you sure you’ll always have this cash to gift? With the uncertainty of the future, you may not have the funds available. A 529 plan guarantees the money because it is held in an account meant for college costs. You could incur hefty fees and taxes for early, non-college related withdrawals, which could make you think twice before spending it, unlike cash.
CONCLUSION
Whether you want to give cash, start a 529 plan, or are undecided, the decision should be discussed with a financial advisor. There are so many working parts when it comes to giving money, even to your family. Certain strategies may be better or worse for your financial and tax situation. A financial professional can help determine what the best plan is for you. At RGA, we take the whole picture into consideration—even the future. Come in for a complimentary consultation so we can answer your college funding questions. Call 1-800-467-8152 or email info@ronaldgelok.com to schedule a time.
SOURCES
https://studentloanhero.com/featured/paying-for-college-pros-cons-529-plan/
https://www.petersons.com/blog/the-pros-and-cons-of-using-a-529-plan-to-save-for-college/
https://www.thebalance.com/what-are-the-disadvantages-of-529-plans-4584843
https://www.savingforcollege.com/article/yes-your-529-plan-will-affect-financial-aid
