There are two certainties in life: 1) College is expensive, and getting more so every year, and 2) Grandparents love their grandchildren. More and more, grandparents are helping pay for their grandchildren’s college education. A recent survey shows that upwards of 50 percent of grandparents are actively saving to fund these education expenses.
While generous, I still counsel my clients to think carefully on how “helping with college” fits into their overall financial picture. Done the wrong way, contributing to the college education fund could put the grandparent’s retirement at risk, and even reduce the amount of financial aid the grandchild could potentially receive from the school.
Here are six steps you should take when it comes to college planning for your grandchildren.
Step 1. How does paying for college fit into your overall plans?
This conversation should start with a thorough and complete review of your overall financial plan. What are your goals and objectives, especially about retirement? Only once you understand your full financial picture — and how comfortable your future may be — should you then create a strategy for this kind of gift being passed to younger generations. Paying for the grandchildren’s college shouldn’t be considered in isolation.
Step 2. Can you afford it?
Everything in life is a tradeoff. You don’t want a gift to put your financial health in jeopardy. What if there’s a long-term care event or a death in the family? Your grandchildren can get a loan for college expenses, but no one gives loans for retirement or health care needs.
Step 3. Know your options
There are a number of ways to approach saving and paying for college.
529 Plans. These plans allow assets to grow tax-free if the money is used for educational purposes — elementary, middle, or high school expenses in addition to college. But, while 529 plans are a popular and powerful tool, they are not the only option for college education planning.
Among the little known facts about 529 plans: You can front-load money into the plan. People think they’re limited to either a monthly or an annual contribution, but the reality is you can put up to $75,000 into a 529 immediately, using five years of a $15,000 contribution all at once.
The downside to 529 plans is they involve age-based portfolios, which shift to a more conservative approach as the child reaches the age of 13 or 14. This may not be right for all circumstances.
Uniform Gift, Uniform Transfer to Minors (UGMA and UMTA). With these, the assets given to a child that is under 18 are held in an account that is managed by an adult. The income from these investments is taxed at the child’s tax rate, which is presumably lower than that of the parents. One critical consideration though: Once the child comes of age, they can legally use the money for anything they want, not just college.
Coverdell. There are a tremendous number of investment choices in a Coverdell Education Savings Account. This is a plus when compared to 529 plans, but contributions are limited to $2,000 per year.
Cash-Value Life Insurance. Life insurance is also tax-advantaged, as the cash value of the policy grows tax-free. Withdrawals of the cash value are also tax free, and the money can be used in paying for college or any other purpose. The insurance coverage would be on the child, owned by the parent or grandparent, which lowers the cost of the insurance and maximizes the growth of the cash value.
Step 4. Be careful not to jeopardize student financial aid
When it comes time to go to college, students and their parents must complete the FAFSA form, outlining all assets and sources of income to apply for financial aid. Each year, 20 percent of any assets in the student’s name are counted toward the Expected Family Contribution (EFC) to pay for college.
UGMA and UTMA accounts are counted as part of the student’s assets. Happily, the money in 529 plans held by grandparents is not considered in the FAFSA calculations, though any withdrawals from the plan used to pay college expenses will be considered student income.
Cash value life insurance is also not considered in the FAFSA form. This makes cash-value life insurance an excellent vehicle for college savings for grandchildren.
Step 5. Consider alternatives to outright gifts
Consider paying directly to the school, or paying off the loans, rather than giving the money outright to the grandchild. If you pay directly to the institution, you can contribute more than $15,000 per year. For loans, because there is no prepayment penalty and the interest is deferred, some grandparents are aggressively paying down the loans while the student is still in school.
Step 6. Start early
Ideally, the process should start before kindergarten. That maximizes the number of annual contributions you can make, and it also takes advantage of the benefits of compound interest. If your strategy involves using cash value life insurance, it also allows you to use more of your premium dollar to fund the accumulation of cash value. The younger the insured, the lower the cost of insurance.
Grandchildren are a joy, and helping them with their college education is a fabulous and very generous gift. Talk to your financial professional about how this fits into your overall financial plans and the best strategy for making it happen.
Accessing cash values may result in surrender fees and charges, may require additional premium payments to maintain coverage, and will reduce the death benefit and policy values. Loans and other policy withdrawals may be taxable under certain circumstances.
For educational purposes only. This information is based upon our understanding of current laws, which is subject to change. Penn Mutual and its affiliates do not provide tax or legal advice. Please talk to a licensed attorney regarding your specific situation.