Tips for grandparents on giving money for college

Q. My daughter is having her first baby and I want to give a money gift for college. What’s the best way to do this?
— Grandma

A. Congratulations on your new grandchild!

Your daughter is very fortunate that her child has grandparents who are both willing and able to help contribute to her college education costs. However, if the proper steps aren’t followed it could wind up costing your grandchild money.

Once you understand the rules it becomes easy to help pay for college the smart way.

Let’s start with the IRS.

The 2016 gift tax exclusion is $14,000, which means that you can give up to $14,000 to a single individual without it counting towards your lifetime gift tax exemption, said Matthew DeFelice, a certified financial planner with U.S. Financial Services in Fairfield.

As a couple, both grandparents could gift $14,000 each for a total of $28,000 to a single grandchild, he said.

But when it comes to 529 plans, there is a special exemption.

“Up to five years’ worth of the gift tax exemption could be given as a lump sum at once if contributed directly into a 529 plan,” he said. “So if you are so inclined and have the means to do so, each grandparent can gift $70,000 to the grandchild.”

Next, you need to understand what type of account to establish.

DeFelice said UGMA (Uniform Gift to Minors Act) accounts were used almost exclusively by the previous generation as an easy way to gift money to children under the age of 18. However, he said, IRS rules have changed dramatically over the years, and the tax benefits UGMA accounts used to receive have been all but eliminated.

“Another downside is that the minor child gains control of the money in a UGMA account once they turn 18 – so if he/she decides to skip college to go backpack across Europe with the money, they legally will be able to do so,” he said.

Typically, DeFelice said, the best way for grandparents to help their grandchildren pay for college is to establish a 529 plan. He said it’s simply the most efficient way to save for college that exists today.

“The child is listed as the beneficiary, and the owner of the account retains control of the assets,” he said. “Additionally, any gains in the 529 plan are exempt from tax as long as the funds are used to pay for qualified higher education expenses such as like tuition, room and board, computers, books, etc.”

DeFelice said it’s important that you understand how your gift can impact potential future financial aid awards. The amount of financial aid families qualify for is calculated by a formula called the Expected Family Contribution (EFC), which takes into consideration both the parent’s and the student’s assets. If gifts are given by grandparents incorrectly, it could reduce potential financial aid and make college a lot more expensive, he said.

He offered this example: If you set up the 529 account listing yourself — the grandparent — as the owner, this account is ultimately treated as a student asset on the EFC calculation and is assessed at a much higher rate than parents’ assets are.

Furthermore, he said, tuition payments out of a grandparent-owned 529 account for the first year of college and each year thereafter count as student income at a rate of 50 percent on the FAFSA (Free Application For Federal Student Aid), which seriously impacts the EFC calculation for the last three years of undergrad.

“We often see grandparents establish 529 plans in their own name for various reasons – they feel the need to maintain control of the funds, for privacy purposes, etc. – and then try to transfer the account into the parents’ names a few years before college starts thinking it will avoid the problem,” he said.

However, most are not aware that at least a dozen states — including New York — prohibit the transfer of ownership of a 529 account unless there is a court order or the account owner dies, DeFelice said.

Because parent assets count much less towards the EFC calculation, it makes sense in most cases for the parent to open a 529 plan as owner, DeFelice said. Grandparents can then gift money into the plan directly or to the parents to deposit into the plan as they see fit.

Email your questions to ask@njmoneyhelp.com.

Karin Price Mueller writes the Bamboozled column for The Star-Ledger and she’s the founder of NJMoneyHelp.com. Click here to sign up for the NJMoneyHelp.com weekly e-newsletter. Like NJMoneyHelp.com on Facebook and follow it on Twitter.