There’s more than one way to help pay a grandchild’s college expenses, and all of them come with tax benefits. Here’s a run through of some options. As always, consult your professional tax advisor to identify what’s best for your situation.
Direct Tuition Payment to the College
Perhaps the simplest strategy – making direct payments to the college – reduces your taxable estate but does not reduce your federal gift and estate tax exemption. You are allowed to make gifts of any amount provided they are used to pay for tuition only – not room and board or any other expenses. This doesn’t mean you can’t give your grandchild additional funds up to the gift exclusion amount (currently $13,000 annually) to help with living expenses. If you are married, the annual tax exclusion doubles to $26,000.
529 College Savings Accounts
These have been around for awhile and offer multiple tax advantages benefiting both the contributor (you) and the student beneficiary (your grandchild). Contributions are allowed to accrue earnings free of federal income taxes, and the grandchild is allowed to withdraw tax-free funds to cover college education expenses. Contributors to their grandchild’s 529 accounts receive tax breaks because contributions are eligible for the annual gift tax exclusion ($13,000). Contributions that stay within the exclusion amount will not adversely affect the contributor’s gift and estate tax exemption. There are other possibilities for larger lump sum contributions to 529 accounts. If this is something you want to explore, your tax expert can explain the tax benefits and other ramifications.
Coverdell Education Savings Accounts
This option allows you to make a contribution annually of up to $2,000 to a Coverdell Education Savings Account (CESA) for a grandchild who is not yet 18 years old. A CESA may be set up by any responsible person to serve exclusively as a means to save for college for a designated account beneficiary. You can set up as many CESA accounts as you want for each of your grandkids. CESA accounts are allowed to earn interest free of federal income tax, and the student beneficiary is allowed to make tax-free withdrawals to pay for tuition, books, supplies, and room and board.
There are some restrictions. Only individuals with a modified adjusted gross income of less than $110,000 (or $220,000 for married joint filers) can set up CESA contributions for their grandkids. Contribution limits may be reduced for incomes between $95,000 and $110,000 ($190,000 and $220,000 jointly). It is perfectly legal to get around the income ceiling by enlisting a responsible person – perhaps the parent of one of your grandkids – to set up the CESA account and to make the contribution on behalf of the child. If you do this, you must trust the person completely because you will have no control over the CESA account going forward.
The above are just some of the options available to grandparents who want to help out with the cost of educating their grandchildren. Please talk to your professional tax advisor for more information on gift tax exclusions and how to find the best tax-smart ways to support your grandchild’s ambitions.