Saving for a Grandchild’s Education Expenses

Helping to pay for college can be a particularly satisfying opportunity for grandparents. Not only do they gain the fulfillment of contributing to their grandchildren’s education, but they also can obtain a tax deduction and estate planning advantages in the process.

One particular college savings strategy got a boost from the recent FAFSA Simplification Act: grandparent-funded 529 plans. These are tax-advantaged savings accounts that may be used for qualified education expenses.

Prior to these recent changes to the FAFSA, distributions from a grandparent-funded 529 plan were considered student income. This counted more than parent savings in the aid eligibility calculation, increasing the expected family contribution and lowering federal financial aid.

Since 2022, student income is no longer required to be reported on the FAFSA application. Therefore, distributions from grandparent savings accounts no longer influence federal financial aid opportunities.

Strategies to Support a Grandchild’s Education

These are some of the most common—and effective—college-funding strategies for grandparents:

1. 529 plans
2. Direct tuition payments
3. Cash gifts
4. Irrevocable trusts

529 plans

Sponsored by all states and the District of Columbia, 529 plans are legally known as “qualified tuition plans”. They derive their name from Section 529 of the Internal Revenue Code, which granted the plans certain federal tax benefits and became law in 1996.

529 plans can be either prepaid tuition plans or education savings plans. They can be a versatile and tax-efficient way to save for a range of continuing education programs, technical programs, undergraduate programs, graduate programs, and even, in some states, K-12 schools. (You can search the U.S. Department of Education’s accreditation database to see if your desired program is listed.)

Like anyone else, grandparents can contribute to 529 plans that they or another person own. They additionally (again, like everyone else) can take advantage of a 529-specific rule that allows for the accounts to be “supercharged” by a large lump-sum contribution.

It works like this. In a single year, each grandparent can contribute five years’ worth of the annual gift-tax exclusion (currently $18,000)—i.e., $90,000—and then split the exclusion over five years. If both grandparents set up 529 plan accounts for the same beneficiary, they can gift in total $180,000 in one shot. That’s enough to fund about 70% of the $241,680 prospective cost for an in-state student at a four-year public institution in 18 years, using the College Savings Plans Network’s online calculator, assuming a 5% interest rate.

Supercharging can be a win-win for the entire family. Grandparents help their grandchildren and reduce their own taxable estate by the amount of the contribution; parents are relieved of the pressure to pay for all college expenses; and grandchildren get a major chunk of their college cost funded in a lump sum years ahead of when they’ll need it so income can grow.

Even if grandparents don’t have enough money to supercharge a 529, they can still take advantage of the attractive tax benefits these accounts offer:

• Contributions are not deductible on federal income tax returns, but many states offer a state income tax deduction as an incentive to use the home-state plan. You can invest in any state 529 plan you wish, so it benefits you to consider not only the state tax deduction, but types of plans, plan costs, and investment offerings, which can include index funds, mutual funds, and professionally managed target-risk and target-date asset allocation funds.
• Account assets grow on a tax-deferred basis until withdrawn.
• Withdrawals of principal are tax-free and withdrawals of gains aren’t subject to federal or state income tax if used for qualified education expenses such as tuition, fees, and room and board. There is a 10% penalty levied on amounts withdrawn for non-education purposes.
• Contributions are considered completed gifts for federal tax purposes. Any contribution over the annual gift tax exclusion would require a gift tax return and count against your lifetime gift tax exemption. In 2024, the annual gift tax exclusion for individuals is $18,000 and for couples filing jointly is $36,000, per year per child.