Should Grandma Pay For College?

Paying for college is a concern for most families with children.  Why not consider Grandma (or any other extended family member) as a resource?  It can be a prudent move if, 1) Grandma, etc. plans to leave the child money in her estate anyway and 2) the child qualifies for Federal financial assistance through the Federal Student Aid application (FAFSA).  A little known secret: the FAFSA calculation for expected family contribution (EFC) excludes assets held for the benefit of the student (as in a 529 plan) if the asset owner is not the student or parent.  If the student uses the pledged assets for education expenses, those sums must be recognized by the student as income under EFC in the year they are received.  It creates a planning opportunity to shelter assets that can be used in the final year of a student’s education, when the EFC calculation no longer affects aid.  Moreover, Grandma can pay education expenses for the student directly from her own funds when they are incurred, without incurring a gift tax or having the payments count toward her annual gift exclusion or lifetime exemption.

But what if you lack a benevolent Granny?  Don’t let that deter the education savings plan for your children.  The burden of education savings looms large for most families, with college costs rising at about a 5% rate over 10 years through 2015 (over twice the rate of overall inflation), with studies showing the average total cost of public in-state undergraduate universities at almost $25k per year (almost $100k overall) and private universities at almost $50k per year (almost $200k overall) in 2017.  Savings must cover the education costs that grants, scholarships, work-study and loans do not.  If you resolve to save for these costs, where should these savings go?  There are two primary tax-advantaged education savings vehicles, with the following attributes:

Coverdell Education Savings Accounts (ESA)

• Contributions limited to $2k per beneficiary per year
• Considered an asset of parent for FAFSA 
• Can be withdrawn tax-free if used for any level of education expense, K through post-graduate
• Beneficiary changes permitted, but it is a non-revocable contribution (beneficiary cannot be the donor)
• Account control passes to beneficiary at age of 18

529 Plans 

• Contributions potentially deductible on state tax returns depending on state laws
• Contributions considered a gift and eligible for $14k annual gift exclusion, with a one-time 5 year contribution ($70k individual/$140k per couple) without gift tax consequences.  High contribution limit ($100 – $350k) per donor.
• Considered an asset of the donor for FAFSA
• Can be withdrawn and used for college, vocational, and post-graduate expenses (tuition, room/board, books, supplies) without tax consequences
• Remains an asset of donor, with beneficiary changes permitted
• Some education institutions may soon match 529 withdrawals with grants.  Washington College in Maryland recently announced a program to match up to $2.5k in 529 plan withdrawals for qualified expenses per student.  

529 plans are sponsored by states to accommodate the state-specific tax laws on contributions, so pick one with full knowledge of your tax situation.  Between the ESA, 529, and potentially taxable savings for pre-college expenses, families have tools to help shoulder their education cost burdens.  It takes planning and forethought, however.  The benevolent Granny wouldn’t hurt, either.