Smart strategies for grandparents funding college costs

It's the time of year when the parents of college-bound seniors may be looking at rising tuition costs and saying, "How exactly will we pay for all of this?"

One increasingly popular solution is that grandparents are contributing more to their grandchildren's education than ever. Some careful planning and professional guidance can minimize any potential financial downsides for you or your grandchild.

"Many of today's grandparents are Baby Boomers, and this generation is all about family," says Greg Carlo, a financial planning consultant at Thrivent with a focus on college planning. "They want to see their grandchildren succeed."

"Often, they weren't able to provide as much support during that time for their own children and may not have been college students themselves," he adds. "So, it's almost like they're making up for these things. They're expressing their values in a purposeful way."

Other than the joy they feel by giving generously, there are a few other reasons why grandparents may be upping their financial support:

• Tuition costs continue to rise. According to Sallie Mae, American families spent an average of $28,026 on college costs in academic year 2022-23. Parents funded 50% of this expense on average, using income and savings.

• A volatile economy has left parents less able to pay. Parents may be less prepared to handle tuition expenses given current economic conditions. Thrivent's Consumer Financial Outlook Survey found that more than three-quarters of those surveyed (76%) said inflation/cost increases are negatively impacting their savings and putting them in a more vulnerable financial position

• Grandparents may enjoy tax advantages. IRS gift-tax provisions work in favor of generous grandparents. The annual gift-tax exclusion permits a gift of up to $17,000 annually in 2023 or $18,000 annually in 2024 for educational purposes without tax implications. What's more, both grandparents can do this for a total $34,000 in 2023 or $36,000 in 2024.

You'll want to do some basic fact-finding before you make any commitment to your grandchild's education. Get started by taking these three steps:

1. Calculate the total estimated expense. Work with your family to articulate as detailed a plan as possible, taking into account the school itself, living expenses, and travel costs. Don't forget to account for money already saved.

2. Establish your financial limits. How much can you comfortably give, without altering your retirement plan? Consult with your financial advisor to assess your portfolio and make a determination.

3. Learn how your contributions may affect your grandchild's financial aid awards. Gifts can be deemed as income and potentially reduce any loans or grants.

"For example, the Free Application for Federal Student Aid (FAFSA) considers both the parents' and the student's assets," Carlo explains. "The parents' assets are mostly protected because it's understood that they need to retire in the future. But a student's saving and income are fair game,"

"And while there are some allowances, each situation differs," he adds. "Before you give your grandchild any money, it's important to understand how a school determines financial need. Then you can work with a financial advisor to figure out the best way to help your grandchild."

Get a head start on your grandchild's future by making contributions as soon as they're born. Each of these options comes with important considerations:

When you make a gift to a 529,¹ you can also take advantage of the aforementioned $17,000 annual gift-tax exclusion for 2023 ($18,000 in 2024.) So the earlier you get started, the more time you have to contribute.

Additionally, IRS provisions let you stack up five years of contributions at once. For example, if both you and your spouse can take advantage of this option in 2024; you can each contribute a total of $90,000 each in the same year, towards five years of gifts, without any tax consequences.² And depending upon where you and your grandchild reside, state tax benefits may also apply.

You'll enjoy more flexibility with your own 529, while also getting the maximum gift-tax exclusions. For example, you can opt to gift another grandchild from the same account as long as they are a beneficiary on the account. And since the money in the fund is considered yours, you can also opt to not give it at all if your circumstances change. (Though earnings will be subject to income tax and a 10% penalty.)

Your gifts may result in reductions to your grandchild's financial aid package since the distribution can be considered non-taxed income. For this reason, consider withholding your gift until their senior year, after all financial aid reviews are complete. Talk with your financial advisor about how setting up a 529 account can impact your financial picture – particularly your retirement strategy.

Also known as an "education IRA," a Coverdell functions much like a Roth IRA—after-tax contributions (up to $2,000 annually) grow tax-free, as long as they're applied to the beneficiary's qualified educational expenses (tuition and fees, books and other learning materials. After graduation, any remaining balance must be withdrawn before the beneficiary's 30th birthday, and the IRS will tax distributions as income.

What to consider: Ultimately, your contributions are limited. And while the student can withdraw any remaining funds after graduation, the earnings will be subject to income tax and a likely 10% penalty.

For some grandparents and situations, a Coverdell may not be the most practical option. "Since you can only contribute up to $2,000 annually, and only until the student turns 18, it's not the most efficient way to give for those who are able to contribute more," Carlo notes.

"A 529 makes more sense, even if you can't give more than $2,000 in some years," he adds. "What's more, you can reassign the 529 account to another grandchild if the initial beneficiary fails to use all the funds."

Opening a traditional or Roth IRA with a custodial provision for your grandchild (the account beneficiary), a custodial account under the Uniform Gifts to Minors Act (UGMA) or Uniform Transfers to Minors Act (UTMA), or gifting U.S. savings bonds, are yet more ways to make education contributions. Consult with your accountant about the potential for taxes and penalties when using these types of accounts for education funding.

What to consider: By definition, investment accounts are not education-specific. The beneficiary can do as they please with the funds once they reach legal age. Savings bonds may provide guaranteed interest, but is it sufficient to keep up with inflation and rising tuition rates for the next decade or so?

Shot of a mature grandmother reading her granddaughter a story at home

A story before bedtime

Considerations for gifting money to grandkids

Gifting money to grandchildren can set a strong foundation for their financial future and serve as a valuable estate planning tool for yourself. Whether you're gifting cash or assets, you'll want to ensure your contribution can make the positive difference you intended—without excessive taxes.

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Even if your grandchild is only five or so years away from going to college, you can still catch up. Weigh the benefits and liabilities of these ways to give:

Using the aforementioned tax-code provision, you can give up to $80,000 at once ($90,000—2024), in lieu of five annual gifts, without tax consequences.

What to consider: As mentioned above, your contributions may impact your grandchild's financial aid eligibility, so make sure you understand those implications.

If you'd like to encourage your grandchild's autonomy and sense of fiscal responsibility, you can loan them the money. If you charge interest (required by the IRS for loans in excess of $10,000), you'll be taxed on those interest proceeds. However, unlike a gift, this funding means will not impact the financial aid package.

What to consider: You can always forgive the loan, though your grandchild may need to pay income tax as a result. They also can't enjoy any tax deductions on the interest they pay, as in many other loan arrangements.

It's the most straightforward way to contribute to your grandchild's education, while still enjoying a tax break: whatever amount you pay to the school is exempt, under tax-code provisions.

What to consider: Your payment may be treated as student income, diminishing the potential aid package.

Yes, this is an attractive option for a couple of reasons: the most important one is that your generosity won't affect their financial aid during their education – and you're also incentivizing them to keep to their goals and graduate.

But remember, any loan payments you make are considered taxable gifts beyond $17,000 in 2023 or $18,000 in 2024 per individual. That's not a lot considering what your grandchild may owe after four years at even a state college or university.

When you take the time to discuss your grandchild's, or grandchildren's, education plans and set your own financial boundaries, you're in the best position possible for creating a lasting legacy. And the best thing? With proper planning, you can do it all without impacting your carefully planned-for retirement.

To learn more about the many ways you can contribute to your grandchild's college education, connect with a Thrivent financial advisor.