Many grandparents want to leave an educational legacy by helping

fund a grandchild’s college education. Grandparents recognize the

value of education and want to see their grandchildren graduate

without excessive student loan debt. 

However, it can be challenging to determine the best way to help

grandchildren pay for college and what forms of help your children and

grandchildren would appreciate the most.

Grandparents should take a proactive approach and raise the subject

well in advance, so parents clearly understand their savings goals and

how much help they can provide. 

Grandparents can encourage parents and students to plan early and

to really look at how much colleges cost after any potential aid. The

major mistake many families make is finding the school first —

typically without regard to cost- and then hoping they get enough aid

to make the school affordable.

With accurate numbers in mind and realistic goals, families can

choose the best course of action. Here are five different ways

grandparents can help pay for college:

1. Pay tuition directly to your grandchild’s school

Under a special tax-code exemption, the amount of tuition a

grandparent pays the school will not be subject to the gift tax.  If you

choose this method, remember that the gift-tax exclusion only applies

to tuition and does not include books, supplies, and room and board.

It’s a simple way to pay for your grandchild’s college.

2. Open a 529 plan in your name 

529 accounts offer tax-free earnings and tax-free withdrawals when

the money is spent on qualified higher education expenses, including

tuition, books, supplies, and some room and board costs. You can

deposit up to $85,000 into a 529 plan without incurring gift taxes when

you elect to treat the contribution as if it were made over a five-year

period. Your grandchild can use the funds from a 529 plan to pay for

any eligible post-secondary institution. Depending on where you live

and which plan you open, you may get a state tax credit or deduction

for your contributions. 

The earnings portion of non-qualified withdrawals are subject to

income tax as well as a 10% penalty (there are special exceptions to

the penalty when the beneficiary dies, becomes disabled, gets a

scholarship, receives educational assistance through a qualifying

employer program, or attends a U.S. Military Academy). In some

states, money saved in your 529 account will be considered available

assets that must be spent on medical and long-term care expenses

before Medicaid can begin.

3. Offer your grandchild a loan

You can give an interest-free loan of up to $10,000. Loan amounts

greater than $10,000 will be subject to a minimum IRS-set interest

rate, but these rates are typically very low. 

One of the advantages of this method is you get to set the terms. For

example, you could allow interest to accrue until graduation, require

interest-only payments for a specified amount of time, or eventually

convert the loan to a gift.

When setting the terms, keep in mind interest on the loan will be

taxable to you but not deductible by your grandchild. And if you forgive

the loan in your will, your grandchild may end up owing income tax on

the debt forgiveness. Above all, be aware that loaning money always

carries some risk—holidays could become awkward if your grandchild

refuses to repay the loan. 

4. Pay off your grandchild’s student loans after they graduate 

If you choose to help in this way, it will not affect the grandchild’s

financial aid eligibility, and your grandchild will have an incentive to

graduate.

But one potential drawback to note: Your loan payments will be

considered gifts, so any amount you give over $17,000 in one year will

be subject to gift tax ($34,000 for married couples filing jointly). And

unforeseen circumstances, such as death or illness, before your

grandchild graduates may prevent you from being able to keep your

promise. 

5. Set up an education trust 

Trusts provide a measure of control because you can specify your

wishes in the trust agreement, and the trustee will be legally obligated

to fulfill them. You can also restrict your grandchild’s access to the

funds regardless of their age. 

However, legal and accounting fees can be high to establish and

maintain a trust. Gifts are irrevocable, meaning that once you create

the trust, you can’t undo it and get the funds back without the trustee's

and beneficiaries' consent. Any income earned in the trust will be

taxed at high rates. 

The Bottom Line

Grandparents can play a vital role in helping grandchildren prepare for

college. From contributing to college funds to being an active member

of their fan club, every effort you make has the potential to make a

lasting impact.