One of the best ways to support your grandchildren is by investing in their education. With rising education costs, it’s never too early to start thinking about your grandchild’s future.
Here are 3 easy ways to give your grandkids the gift of education.
1. Cash Gifts
The most straightforward way to fund your grandchild’s education is by paying the institution directly. When you pay like this, you aren’t bound by the annual gift tax exclusion (more on that later).
You may also decide to give your grandchildren cash gifts to help support their education journey. But, there are some things to consider before you choose this option.
- You stay within the gift tax limits unless you pay directly to the institution.
- You ensure the gift is age-appropriate
What’s An Age-Appropriate Cash Gift?
Don’t pull out your wallet just yet! Not every child is ready to handle a large sum of money. If your grandchild needs more time to master money management, consider giving the money to their parent to help ensure they spend it wisely.
But remember, you don’t have to pay for four years of tuition to show your grandchildren that you care! Supporting their education can be as simple as sending them some school supplies. Any gift that encourages them to study, learn, and grow is an excellent investment.
2. College Education Funding Investments
There are a couple of crucial investment options regarding education expenses. Each investment plan has unique benefits, like tax exemptions and interest gains.
Review each to uncover which options suit you and your family’s situation.
With federal tax-free earnings and withdrawals for education expenses (like tuition, textbooks, supplies, etc.), it’s easy to see why the 529 plan is one of the most popular college investment accounts.
Over 30 states also offer a full or partial tax deduction for 529 plan contributions. If you’re a South Carolina resident contributing to the state’s 529 plan, you can deduct any contributions you make within the year—there are no limitations on deductions, a rare tax advantage.
It’s important to thoughtfully select the plan owner as it could affect the student’s financial aid eligibility. If the account remains in your name (the grandparent), the funds aren’t counted on the current year’s FAFSA but will count as untaxed income on the following year’s form.
You could also keep the account in the parent’s name. If you do this, the plan is considered a parental asset and can only decrease your grandchild’s financial aid eligibility by a maximum of 5.64% of the account’s value.
Key Benefits of 529 Plans
- Federal tax-free growth and withdrawals
- May allow for state tax deductions
- No income, age, or annual contribution limits
Drawbacks of 529 Plans
- Limited investment options
- Not all 529 plans are the same
- 529s can interfere with federal aid
Series EE and I Savings Bonds
A savings bond is a long-term loan to the government that pays interest over time.
Series EE and I bonds are safe investment options as they provide guaranteed interest when you hold them to their maturity date. To avoid penalties, you must also hang onto these bonds for at least five years.
The safety of these investments comes with a price: lower interest rates than other types of investments. But remember that if you purchase an I bond, you can lock in a 9.62% interest rate for six months!
When you use Series EE and I bonds to pay for higher education, you may be able to redeem them tax-free. Plus, bond interest is usually exempt from state and local taxes.
Note: Your grandchild must be your dependent to receive the tax exclusion as a grandparent. Otherwise, you will have to pay income tax upon redemption.
Benefits of Government Bonds
- Easy to purchase
- Guaranteed interest (when held to maturity)
- Tax-free distributions (restrictions apply)
Drawbacks of Government Bonds
- Low-interest rates
- Limitations to the tax exclusion
- Penalties if not held to maturity
- Can’t use it to pay for room and board costs or textbooks
Although generally used for retirement, you can also use your Roth IRA to help pay for your grandchild’s education.
Funded with after-tax dollars, these retirement investments grow tax-free, and interest can be withdrawn for educational purposes without a penalty (though you’ll still have to pay income taxes if you’re under 59½ and the account is less than 5 years old).
Conversely, you can withdraw contributions at any time, for any reason, tax-free. Unlike some 529 plans, there’s no state income tax deduction for Roth IRAs.
Before you start taking money from your Roth IRA, make sure you are well-funded for retirement in other ways. You can’t put back the money you take out unless you are still working. Even then, there are still contribution limits to keep in mind (max: $6,000 per year as of 2022 with a $1,000 catch-up if at least 50).
Money inside the Roth IRA will not affect your student’s eligibility for need-based aid. However, withdrawals will count as untaxed income for FAFSA purposes and can negatively impact your grandchild’s financial aid package.
To prevent this, wait to use a Roth IRA distribution to pay for college until the student has filled out the FAFSA for the second year of college.
Benefits of Roth IRAs
- No age limits
- Tax-free growth
- Greater investment selection
Drawbacks of Roth IRAs
- Potentially leaves you with less money for retirement
- It might affect your grandchild’s need-based financial aid
- Income and contribution limits
3. Other Funding Opportunities Without Spending Requirements
While the previous investment accounts are all education-specific, the following funding opportunities don’t have spending conditions.
A custodial account is an investment account you can create for your grandchild, but you manage until they reach the age of maturity, usually 18. Once that happens, the funds become theirs, and they can spend them however they want.
Investment income in this type of account may trigger a kiddie tax. If your grandchild’s unearned income from custodial accounts totals more than $2,100, some of that income will be taxed at their parent’s tax rate instead of the child’s lower rate.
A custodial account may significantly impact your grandchild’s financial aid package. Because the money in a custodial account is your grandchild’s asset and not yours, FAFSA considers 20% of the funds available to pay for college. Other accounts (like 529s) have more favorable treatment for financial aid.
Benefits of Custodial Accounts
- Not limited to education expenses
- No contribution limits
- Many investment options
Drawbacks of Custodial Accounts
- Lack of control
- Potential Kiddie tax
- May greatly affect financial aid
Permanent Life Insurance Policy
You can use the cash value of permanent life insurance policies to pay for anything, including tuition. Permanent life insurance policies have a cash value that increases over time, and that value is yours to use as needed.
Since the money amassed in a permanent life insurance policy doesn’t count as an asset on the FAFSA, it won’t affect your student’s financial aid.
Benefits of Permanent Life Insurance
- Won’t affect financial aid
- Account flexibility
- Cash withdrawals
- Ability to borrow against the account
Drawbacks of Permanent Life Insurance
- May decrease death benefit
- Significant upfront and recurring fees
- Slow growth
Mind The Gift Tax Gap
When you give an asset to another person and don’t receive something of equal value in return, the IRS considers this a gift. And they limit how much you can give in a year.
Understand 2022 Gift Tax Limits
No need to worry about that $25 gift card or new laptop you just bought your grandchild; the gift tax only applies to gifts that exceed the annual limit of $16,000 or $32,000 for married couples (in 2022).
Stay below this annual limit, and you can be generous under the radar. Go above, and you’ll have to fill out a gift tax form— but you still might avoid paying any gift tax!
Remember, if you pay the school directly, you can circumvent the gift tax rules.
Thanks to the lifetime exemption, you won’t owe the tax until you’ve given away more than $12.06 million per person and $24.12 million for married couples (as of 2022) in gifts during your lifetime.
Any amount you give over the annual limit automatically applies to your lifetime exemption.
For example, if you give your grandkid $50,000 this year, you’ll still need to file a gift tax return, but you probably won’t pay a gift tax, at least not immediately.
How come? Because the excess $34,000 not covered by the annual exemption simply counts against your lifetime exclusion.
A unique rule allows gift givers to spread one-time gifts across five years to preserve their lifetime gift exclusion.
You may circumvent the gift tax altogether by paying tuition or medical expenses directly to the institution.
What Can Trigger a Gift Tax Return?
Gift taxes can be sneaky. They can apply to everything from laid-back loans to adding a grandchild to a bank account. Anytime you give someone access to assets worth more than the annual limit, you can trigger the gift tax.
Consult a Financial Advisor First
Helping your grandchildren receive an education is a wonderful position to be in. However, like in many areas of financial planning, the exceptions, taxes, and rules can quickly intertwine and become confusing.
Although generous, big financial gifts can cause harm by negatively impacting your grandchild’s financial aid package. When making important financial plans, it’s always a good idea to consult a financial advisor.
Our fiduciary advisors at Goepper Burkhardt Wealth Management can help you maximize your grandchild’s financial support.
We’re eager to help set your grandchildren up for financial and educational success. Reach out to us anytime to get started.