Hugh F. Wynn
Grandparents Are Special: Setting up Grandkids for Success
Want to know how to help youngsters earn a degree without accumulating huge debt?
While anticipating the pending stampede by high schoolers to institutions of higher learning this fall, let’s dwell a bit on how to help youngsters earn a degree without accumulating huge debt that could burden their future for decades. This is increasingly important because, based on my studies, a college degree doesn’t represent the value it once did. And why not? According to the Labor Department, salaries for college graduates have remained essentially flat since the turn of the century (adjusted for inflation). And the price of that degree has soared relative to other cost of living items (a reduced bang for your buck, thanks to Professor Izzy the Inflation Monster). Also, those earning degrees seem not to be accumulating wealth on par with previous generations. The media often proclaims that today’s young adults are less well-off than their parents and grandparents were at various important signposts along life’s journey.
I’m not suggesting that a college degree doesn’t improve one’s opportunity for a bigger paycheck than, say, a nongraduate. On average, it most certainly does. What I am suggesting, however, is that the yield on “earning a degree” is not what it used to be. If true, that should spur folks to look for ways to reduce the cost of an education investment – directly and/or indirectly. A couple of years in a local junior college might be in order. Being a good student and graduating in four years would also help. And a student might even consider working part-time while in school (review Reagan’s Journey Begins in the Wynn$ights "Past Posts"). Or indirectly, some financial assistance from Gramps and Grams could reduce the long-term burden of student debt.
Last week, we talked about Hypothetical Henry and how his parents were preparing for those expensive college years. This week, let’s explore a few more details of a 529 Plan – and another alternative, the Direct Pre-Payment of tuition to an educational institution. According to AARP, in addition sharing wisdom and experience, grandparents spend in the neighborhood of…gasp… $179 billion annually on their grandkids. The figure includes money spent for higher education as well as on other life expenses… even groceries and vacations. No wonder Gramps and Grams are so special.
The 529 Plan
Let’s focus for a moment on how many grandparents do help alleviate some of the financial burden. There’s a world of information on the internet about 529 Plans and Direct Payment of tuition, but some unique factors require discussion when grandparents get involved. For instance, might grandparent assistance jeopardize the grandchild’s need-based financial aid, and how well does it mesh with the grandparents’ own financial planning? And being conservative sorts, grandparents often don’t want to give money directly to their grandchildren. Or perhaps they don’t want to cede control of the funds to others until the funds are actually disbursed.
As mentioned, a downside to grandparents owning the plan (particularly in families seeking need-based aid), the distributions from elders count as student income on the Free Application for Federal Student Aid (fafsa); a designation that weighs much more heavily than parental income in the aid formula.
Still, many grandparents – me included – would rather make contributions annually to a parent-controlled 529 Plan. By ceding, they lose control of the money but gain the benefit of not having to worry about maintaining the account. Some states allow grandparents to own the plan and then cede its ownership to the parents just before the student heads for college. This practice allows grandparents to mostly have their cake and eat it too.
A Quick Review
In case you missed what was footnoted in the previous blog (Hypothetical Henry), 529 Plans are operated by state or educational institutions with certain tax and other advantages to ease the burden of saving for college and other post-secondary training. Likewise, they can be used to pay for tuition at elementary or secondary public, private, or religious schools for the designated beneficiary. Earnings are not subject to federal tax and typically not subject to state tax when used for qualified education expenses such as tuition, fees, books, as well as room and board at eligible education institutions and tuition at elementary or secondary schools. Although contributions to 529 Plans are not deductible for tax purposes, they offer tax-deferred growth and tax-free withdrawals. You won't pay any income taxes on the amount your account earns while it's growing, and if you use the money for qualified education expenses, those earnings will be tax-free when you withdraw them.
Grandparents, if still married, can contribute as much as $30,000 a year to a 529 Plan (per grandchild) without triggering gift-tax consequences. And if they’re into downsizing their estate, or simply feeling extra generous, they can do a “bunch” – contribute five years of annual gifts into the plan in one year without triggering a taxable event. This is often done when establishing the plan to enjoy five-fold, the Amazing Power of Compounding.
We’ll discuss 529 Plan investing in a future blog, but for a quick preview, check out the Vanguard 529 Plan age-based options (conservative, moderate, aggressive) for some ideas. A quick peek will open your eyes to all kinds of investment options.
Direct Payment of Tuition
Grandparents can also write checks directly to a school without triggering Uncle Grabby’s gift-tax rules. In short, they can prepay tuition directly to a university and at the same time, give the grandkid an additional tax-free gift (currently $15,000 per year per grandparent). Unfortunately, this gift tax exemption only applies to tuition expenses and not to those myriad other expenses (countless fees, room and board, books, supplies, etc.).
A word of caution, this prepayment of tuition is typically NOT REFUNDABLE should your grandchild decide to change schools. So, don’t get overly zealous and ante up for all four years. And, yes, this type of grandparent assistance can negatively impact the student’s eligibility for needs-based financial assistance, too. By the way, Gramps, the money you prepay to an institution for a grandchild’s tuition is not a charitable deduction, so don’t get any funny ideas along those lines. Uncle Grabby can be a rough customer to deal with when tested.
There are many other ways to help a kid go to college, but I lean toward the 529 Plan. Still, whatever choice you make, the key is getting started. You’ve heard it before and you’ll hear it again: It’s Never Too late, But Early is Best.