(This article previously appeared on Helpwithaging.com.)
Pay the College Directly
If you write a check directly to the college it won't count toward the maximum amount of annual tax-free gifts you can make.
Otherwise, by law, you can give up to $14,000 a year to any individual without incurring a gift tax; your spouse can give another $14,000, for a total of $28,000.
(MORE: How to Save For College)
A Mistake That Could Cost Your Grandchild
To avoid cutting into any scholarship aid your grandchild might receive, don’t give him or her cash during the year before college starts. That money would be counted as income for financial aid purposes and could reduce any scholarship money by as much as 50 percent of the gift.
Instead, make the gift to your grandchild’s parents. That way, it will be counted as their asset and the reduction in potential financial aid will be a much smaller.
How Assets are Calculated for Student Aid
Here’s how the federal government calculates what's known as the Expected Family Contribution (EFC) to estimate the amount of financial aid a student would qualify to receive, according to Savingforcollege.com. The formula counts the following financial resources as being available to pay college expenses; the percentages for a parent's assets and income are based on a sliding income scale and after certain allowances:
- 20 percent of a student’s assets
- 50 percent of a student’s income (after certain allowances)
- 2.6 to 5.6 percent of a parent’s assets
- 22 to 47 percent of a parent’s income
529 College Plans
One popular approach for grandparents who want to help pay for college is to open a 529 account in their grandchildren's names.
Any money you put in this special college savings plan grows tax-free and the distributions for educational expenses are also tax-free. Many states let you take a tax deduction for the money you deposit in a 529 account. Bear in mind, however, that each 529 plan has its own fees.
(MORE: Grandparents’ Gifts That Keep on Giving)
You can give your grandchild as much as five years worth of tax-free gifts in a single year ($70,000) without incurring a gift tax penalty. If you provide that much money in one year, however, you can’t give anything more for the next four years.
The Savingforcollege.com website has a vast amount of information on 529 plans. And the Morningstar site recently named what it considers the best 529 plans in the nation based on investment options, management and fees. Morningstar also has good advice regarding the tax rules for 529 account owners.
Bundling 529 Gifts for Senior Year
Another tip: Consider making your 529 gift in your grandchild’s senior year of college.
That’s because distributions from a grandparent’s 529 account are counted as student income when determining financial aid for the following year. But that rule doesn't come into play if you put money into the 529 during your grandson or granddaughter’s final school year.
If You’ll Need the 529 Money
Changes in your financial situation might force you to take back the money you’ve put into your grandchild’s 529 plan before it can be used to pay for tuition. In that case, you can withdraw the cash, but you’ll owe taxes and a 10 percent tax penalty on any profits earned in the account.