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Helping a grandchild pay for school

Created date

July 21st, 2014

Many youngsters heading to college this month will graduate with staggering student loan debt. If you want to help your grandchildren pay for higher education, 529 savings plans are widely regarded as one of the best tools.

There are many 529 plans on the market. Rich Polimeni, director of education savings programs for Bank of America Merrill Lynch (wealthmanagement.ml.com), says to look first at plans offered in your home state because you may be able to take an income tax deduction when you make contributions to in-state plans. You’ll also have to choose between a direct or advisor plan. Polimeni says direct plans typically have lower fees because you manage the invested funds yourself. Advisor plans have higher fees because a professional manager directs the investments.

“It’s really similar to looking at mutual fund investments,” Polimeni says. “Look at the investment options, the managers, fees, expenses, performance and track record.”

From an estate planning perspective, contributing to 529 plans can be an effective method to remove assets from an estate to avoid taxes. Current IRS rules limit gifts to $14,000 per recipient per year before gift tax is triggered. However, Texas investment advisor Scott Stratton (goodlifewealth.com) says 529 plans have a special exception to that rule that permits people to fund five years of contributions in one year. That means you can gift a lump sum of up to $70,000, or $140,000 for a married couple, for each beneficiary named in a 529 plan.

Other options

Stratton says 529 plans can only be used to pay for post-secondary education, including graduate programs, community college, and some non-degree trade schools. So, if you want to help pay for a grandchild’s private elementary or high school tuition, ask your advisor about other options. 529 plans also make less sense as the child ages because there won’t be enough time for the invested funds to grow. If your grandchild is within a year or two of starting college, Stratton says to consider paying tuition directly to the school, which won’t trigger a gift tax.

“Additionally, money given to your children or grandchildren will be reported on the FAFSA, which could increase their expected family contribution and potentially reduce their eligibility for other sources of financial aid,” Stratton says.

Likewise, Stratton says grandparents should open 529 plans in their own names and list grandchildren as beneficiaries. Grandparents’ assets aren’t disclosed on the FAFSA, so money you’ve saved in 529 plans on grandchildren’s behalves won’t hurt their chances of receiving financial aid.

In addition to 529 plans, some states offer prepaid tuition plans. Betty Lochner, chair of the College Savings Plans Network (collegesavings.org), says if you purchase a prepaid tuition plan this year, you essentially lock in current tuition rates for your grandchild to attend college later. The cost of plans is typically based on your state’s in-state tuition rates, but Lochner says invested funds can be used to pay tuition at any qualified institution.

“In the beginning, there were some plans that had to be used at a state school, but now in every state, you can use it anywhere,” Lochner says.

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