Nothing feels better than seeing the smile on your loved one’s face when they open your gift during the holidays. Furiously unwrapping the box. Frantically digging through the tissue paper. Hoisting the new treasure into the air for all to see. It’s a wonderful sight (assuming it’s not a bunny costume)!
Now, I fully understand how opening a box that has a piece of paper celebrating a newly opened and funded 529 plan has less visual cache than, say, a PS5. But helping out a grandchild or nephew with the astounding costs of college can increase long-term happiness and reduce anxiety and stress.
The immense cost of college can create an overhang on your loved one’s financial lives for decades. There are several wonderful ways to contribute to their education planning needs, from funding 529 plans to supplementing their student loan payments. But make sure you choose the approach that works best for your own financial situation and implement it properly to maximize the advantages for you and your loved one.
How to Gift to a 529 Plan
While we cover 529 plans in more detail in another blog post, let’s start with a quick refresher on these unique education planning accounts.
A 529 plan is a college savings plan that offers unique tax and financial aid benefits. There are two types of plans: college savings plans and prepaid tuition plans. Every state offers a 529 college savings plan, though not every state offers a prepaid plan (in fact, only nine do at this time).
While contributions to 529 savings plans are not tax-deductible at the federal level, earnings are tax-deferred and withdrawals, if used for qualified education expenses, are not taxed. Note, though, that some states allow 529 savings plan contributions to qualify for a tax-deduction against state income taxes. Each state has their own 529 plan, with different investment options, fees, and tax considerations, so it’s important to consider all factors when choosing the best 529 savings plan for your family.
Now, how can you make a gift to a 529 plan? You can open a new 529 plan account in a child’s name or contribute to an existing account. Contributions to a custodial 529 plan account or to a parent-owned 529 plan will minimize the impact on eligibility for need-based financial aid.
You may be worried about the gift or estate tax implications of making a gift to a 529 plan. However, you can make large contributions to 529 plans without incurring gift taxes, if done properly. As with any other gift, you can contribute $15,000 per beneficiary as part of the annual gift tax exclusion. Further, 529 plans allow for five-year gift tax averaging. You can contribute up to $75,000 immediately and (after filing the proper tax forms) treat the gift as if it were spread out evenly over a five-year period. The gift tax exclusion limit is per gift giver, so couples can gift up to $30,000 per year per child, or $150,000 if using 5-year gift tax averaging.
Note, though, that a grandparent-owned 529 plan can affect a student’s financial aid eligibility. If grandparents provide any sort of financial support for the student (including 529 plan withdrawals), that amount is reported as student income on the FAFSA. As much as 50 percent of student income will count as funds available for college, severely inhibiting any needs-based aid eligibility.
How to Gift a Student Loan Payment
Let’s say your loved one has already completed their college journey and are now saddled with significant student debt. You want to help out, but how?
One option is to be added as a cosigner on the loan. Adding a cosigner when refinancing student loans can make it easier to qualify for and receive lower interest rates. Further, loan cosigners can make tax-free donations of any amount to pay for the loan. Of course, adding yourself as a cosigner has its own tax and legal considerations, since you will now effectively be guaranteeing the person for whom you are cosigning will repay the debt on-time and in-full.
Another option is to add yourself as an authorized payer on the loan. Many student loan servicers allow family members to become an authorized payer on the loan. From there, you can make direct payments as you see fit. Of course, gift tax considerations apply here.
Don’t feel like you need to wait for graduation to help your loved one reduce their debt burden. You can help them pay for their loans while they are still in school, reducing their monthly payments before they even start!
Other Ways to Gift Education
If your loved one is already in school, the advantage of tax-deferred compounding within a 529 plan is minimal, if any. However, you still have education gifting options at your disposal.
For instance, you can make direct payments to the school for tuition, and none of the payments count against annual (or lifetime) gift tax exemptions. Note, the payment must be made only for tuition. Payments for books or travel would indeed count against the annual (and, potentially) lifetime limits.
Timing also matters in this situation. Since the FAFSA is based on a two-year lookback, the ideal scenario is to spend down a 529 account in the first two years (if the 529 account is in the student’s name) and then pay the school directly for the last two years of school.
Before you make any kind of direct payment of tuition, however, check with your grandchild’s college about its policies. Some colleges may consider the payment as a resource that reduces eligibility for need-based aid, dollar for dollar.
Finally, some employers are starting to offer student loan repayment assistance as part of their benefits package. These payments are usually considered taxable income for the recipients, and (as of December 2020, at least) the payments are not tax-deductible for employers.
However, there are ways of structuring the arrangement to hit on both student loan payments and retirement savings goals. For instance, an employer could offer to contribute to an employee’s retirement account (which is tax-deductible for the employer) if the employee uses some percentage of his or her salary to make student loan payments.
Education Planning with Harbor Crest Wealth Advisors
I can speak from personal experience about the financial and emotional overhang of trying to pay down student loans as one enters the workforce. And while tuition inflation has moderated recently, attending college is an exceptionally expensive endeavor. You can help reduce the burden on your loved ones by choosing an approach that fits into your own financial life and maximizes the advantages for all.
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