Why Universities can't share grades (and how to fix it)
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Grandchildren are a precious gift, and it is natural to want to help them with their college education. While there are several options available, it is important to understand the pros and cons of each, as well as their impact on financial aid eligibility and the Expected Family Contribution (EFC) calculation. As a general principle, you want to avoid any strategy that will be reported as a grandchild's income or assets.
Cash Gifts - Most often, grandparents choose to make cash gifts to their grandchildren to help fund their education. The annual gift tax exclusion allows grandparents to give up to $15,000 per year per grandchild without incurring gift taxes. While this option is simple and is the most flexible, cash gifts to grandchildren are considered part of the grandchild's untaxed income in the year they are given. Gifts held as cash are reported as a grandchild's asset. Either way, the cash gift will negatively impact the grandchild's financial aid eligibility.
Recommendation - Avoid giving cash gifts to directly grandchildren from their junior year of high school until they graduate from college, including direct payments for tuition. Instead, consider gifting money to a 529 account, or to the parents as these strategies will have less of an impact on financial aid eligibility.
529 Plan - A 529 plan is a tax-advantaged savings plan designed specifically for education expenses. Contributions to a 529 plan grow tax-free and are not subject to federal income tax when withdrawn for qualified education expenses. Certain states offer a state income tax deduction for 529 plan contributions. Grandparents can open a 529 plan in their own name for the benefit of a grandchild that will not be reportable on financial aid forms. However, funds withdrawn from a grandparent's 529 account to pay a student's education expenses will be counted as student untaxed income, which will reduce financial aid eligibility.
Recommendation - Prior to filling out the FAFSA, transfer the grandparent's 529 funds into the parent's name. The rollover will increase the student's EFC, but less than the distributions for tuition payments. Under the provisions of Secure Act 2.0, unused 529 funds can be rolled over into a Roth IRA in the grandchild's name with certain limitations. Grandparents can also wait until the grandchild's senior year or after graduation to use the 529 funds.
UGMA/UTMA Accounts - grandparents can establish a custodial account for their grandchild through the Uniform Gifts to Minors Act (UGMA) or the Uniform Transfers to Minors Act (UTMA). These accounts allow grandparents to make contributions on behalf of their grandchild, which are then held in a custodial account until the child reaches adulthood. Funds held in a UGMA/UTMA account do not need to be used for education and have more flexible investment options. However, UGMA/UTMA are reportable as student assets on the FAFSA, which reduces financial aid eligibility.
Recommendation - consider moving the money in the UGMA/UTMA account into a custodial 529 account in the parent's name. This will have less of an impact on expected family contribution. Or, consider spending the UGMA/UTMA money on necessary expenses for the student's benefit so they can receive more financial aid in subsequent years.
Cash Value Life Insurance - cash value life insurance provides both a death benefit and a savings component that grows tax-deferred. Life insurance assets are not reportable on the FAFSA, so many financial advisors will recommend cash value life insurance as a gifting strategy. However, it is very important to ensure the policy type and scheduled distributions do not result in unwanted tax consequences, higher future premiums, or reduced financial aid eligibility.
Recommendation: cash value life insurance has benefits and risks as a education gifting strategy, and the person selling the policy may or may not fully understand them. Be wary, ask a lot of questions, and don't commit to anything without a second opinion. The assumed scenarios are heavily dependent on interest rates and other factors.
If you have a particular gifting strategy in mind, or would like to speak further about these options, feel free to contact me to set up a consultation.