A grandparents’ guide to funding college


Maximizing college educational aid while minimizing taxes on contributions is complicated, even if a taxpayer is familiar with the alphabet soup of FAFSA, UGMA, and UTMA, to say nothing of 529 plans and Coverdell education savings accounts — and the interplay between these and financial aid can be confusing to taxpayers and their accountants. A monetary gift to a grandchild may result in a tax event on the grandparents’ end or interfere with financial aid eligibility for the student

For example, a parent or grandparent can gift up to the annual exclusion without paying gift tax, noted Billie Jo Weis, a former CPA and director of client services for My College Planning Team. “However, that monetary gift will count as untaxed income, which may reduce the child’s aid eligibility on their FAFSA,” she said, referring to the Free Application for Federal Student Aid form. “Ditto if you want to pay your grandchild’s college tuition directly. The gift may not be taxed as a gift from you, but depending on the college, the payment may negatively impact the student’s eligibility for aid.”

The annual gift tax exclusion is $15,000 per donee for 2021, or $16,000 for 2022, she observed.

“This may not matter, of course, if your grandchild isn’t eligible for needs-based aid in the first place,” she noted. “But you may not know until you have a detailed family conversation.”

According to a survey by Fidelity Investments, more than half of American grandparents are either helping to fund their grandchildren’s tuition or planning to do so down the road.

For many grandparents, a qualified tuition program — also known as a Section 529 Plan — offers many advantages, Weis observed: “The existence of a grandparent-owned 529 plan isn’t factored in on the FAFSA. Earnings on the investments are tax-free, and 33 states also offer tax breaks on contributions. Furthermore, withdrawals aren’t taxed if the funds are used for qualified educational costs.”

“However — and it’s a big however — once funds are withdrawn to pay for tuition, distribution is considered income on the student’s FAFSA for the tax year that the FAFSA is asking about,” she warned. “Once again, eligibility for financial aid may suffer.”

As a result, some experts suggest holding off making contributions from a 529 plan until students are college juniors and have filed their last FAFSA, according to Weis. “And be aware that 529 plans vary by state and you have the option to set up an out-of-state plan that may offer more attractive features,” she said.

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Other options include a Uniform Gift to Minors Act (UGMA) or Uniform Transfers to Minors Act (UTMA) account. “These typically offer more investment options than 529 plans, but involve turning control of the account over to the student when they reach a specific age. And if the student is eligible for financial aid, the money in a student UGMA or UTMA will result in a higher [Expected Family Contribution], lowering the financial need eligibility, than if the same funds were invested in a 529 account,” she said.

Coverdell ESAs — formerly known as Education IRAs — are an additional vehicle for saving for college, Weis indicated: “They have a whole different set of pros and cons, but work in similar fashion to a 529 plan.” Maximum contribution limits are lower, and they are only available to families below a specific income level.

The failure to use the appeals process is a mistake made by parents whose situation has changed, according to Jack Schacht, founder of My College Planning Team.

“This is especially true in the COVID era,” he said. “For example, the FAFSA looks at 2020 income when it is filled out in October 2021 for a student attending college in 2022. The college doesn’t know if the income reported for 2020 has dropped. Unless the student files an appeal for more financial aid they will not get it.”

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