Giving the gift of education

THE FACTS: I would like to help defray the cost of college for my grandson, Joe. My daughter and son-in-law are not in a position to pay full tuition, room and board. I don’t want them or Joe to borrow for his education.

THE QUESTION: What is the best way to help out without hurting Joe’s chances of receiving needs-based financial aid?

THE ANSWER: Although there are a number of ways to defray the cost of Joe’s education, including giving him money, giving money to your daughter and son-in-law or paying the college directly, for many people the best way to assist with college expenses is to set up a Section 529 College Savings Plan (a “529 plan”) with Joe as the beneficiary. Your various options are discussed below.

If you want to simply gift money to Joe for his education, you can give him up to $14,000 per year without incurring any gift tax. However, when the college reviews his financial aid application and determines how much Joe should contribute toward his education, they will take any gifts you have given him into consideration. Since students are expected to contribute approximately 20 percent of their savings to their education, the more you give to Joe directly, the less aid he will receive.

If you decide to give money for Joe’s college expenses directly to your daughter and son-in-law, you can gift each of them $14,000 for a total of $28,000 per year. Clearly you can make a larger annual contribution to Joe’s education this way; but, like the funds gifted to Joe, the funds you gift to your daughter and son-in-law will be taken into consideration when calculating any financial aid that may be awarded to Joe. The negative impact of gifting funds to his parents rather than to Joe will be less than the impact of gifts made directly to Joe because his parents are only expected to contribute about 6 percent of their assets to his education.

Paying the college Joe attends directly is an option that avoids any potential gift tax issues on gifts exceeding the $14,000 annual limit. Paying the college directly would allow you to make larger contributions annually to his education; but, this method is not recommended since the money paid directly to the college will be considered as income to Joe. Like gifts to Joe, payments to the college will adversely impact the amount of aid Joe may receive.

In my opinion, the best way to defray the cost of Joe’s college education is to open a 529 plan. Many states, including New York, offer such plans that allow for tax exempt growth on investments so long as distributions from the accounts are used to pay qualified college expenses. Contributions to a 529 plan are subject to gift tax; but, the law allows contributions up to $70,000 to be made in one year as long as the person funding the plan files a gift tax return and applies the contribution over a five-year period.

If you open a 529 plan, you could decide how the funds in the account will be invested and to change the beneficiary in the event Joe decides not to attend college. You could also remove funds from the account for noncollege expenses although such a withdrawal will result in a penalty and tax liability.

Although the income on the investments in the plan will be considered Joe’s income, increasing the amount he will be expected to contribute to his education, it is only assessed at 50 percent as opposed to other income that is assessed at 100 percent so the negative impact is greatly reduced.

In some states you can avoid the negative impact of increasing Joe’s income if you transfer the 529 plan to your daughter before Joe applies for aid. Unfortunately, this option is not available in New York where transfers are prohibited unless the account owner dies or there is a court order. For this reason, it may make more sense if you simply contribute funds to a 529 plan opened by your daughter.

Regardless of the method you decide to use to defray the cost of Joe’s education, it is worth noting that gifts made to Joe or his parents after January of Joe’s junior year of college should not have any impact on his ability to get financial aid. That is because by then Joe will have already filed his aid application for his senior year.

Before you make a decision about how to help Joe and his parents pay for his college education, you should not only look at all the options available to you but you should discuss with an estate planning attorney how Joe’s college education should be addressed in your estate plan. You don’t want your estate plan to jeopardize whatever steps you may take during your lifetime to benefit Joe.

This article first appeared in the December 8, 2017 issue of the Times Beacon Newspapers.

Linda M. Toga provides personalized service and peace of mind to her clients in the areas of estate planning and administration, real estate, marital agreements and litigation out of her Setauket office.

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