How Grandparents Can Save and Gift Money for a Grandchild’s College Education

There are many ways that grandparents can help grandchildren pay for college. These include saving before college, helping during college, and repaying student loans after college.

When you decide to help your grandkids cover their college costs will influence the options that are available to you, including those that have tax and financial aid advantages.

You’ll want to carefully compare the pros and cons of each choice that’s available to you to minimize tax costs and avoid unnecessary reductions in your grandchild’s eligibility for need-based financial. Here’s what you need to know.

How To Help Grandkids Save Money For College

Saving for a grandchild’s college education can increase the likelihood that the grandchild will enroll in and graduate from college. Why?

First, it sets up an expectation well ahead of time that the grandchild will continue their education after high school. Second, spreading out the cost of college over time also makes it easier to save and provides the benefit of compounding to grow the savings faster.

How you save can affect the grandchild’s eligibility for need-based financial aid. It can also affect federal and state income taxes. There are three specialized college savings accounts that have tax and financial aid advantages:

Other savings options include U.S. Savings Bonds, UGTM or UTMA accounts, Roth IRAs in the grandchild’s name and more. Let’s take a looker at the benefits and drawbacks of each option.

Coverdell Education Savings Accounts

Coverdell education savings accounts (ESAs) are more limited than 529 plans. They have a $2,000 annual aggregate contribution limit from all sources and there are income phaseouts on contributors. 

Coverdell ESAs also have age limits: contributions must end when the grandchild reaches age 18 and the money must be used by age 30. But these accounts offer more flexible investment options and can be used to pay for K-12 education costs in addition to college costs.

Prepaid Tuition Plans

Prepaid tuition plans claim to lock in college tuition costs at current prices. But they unfortunately often fall short of those promises. 

Many prepaid tuition plans suffer from actuarial shortfalls and are closed to new participants. Only about a dozen prepaid tuition plans remain available. 

529 College Savings Plans

529 college savings plans offer estate planning benefits. Contributions are immediately removed from the contributor’s estate. But the account owner retains control over the funds. Grandparents can contribute up to $17,000 per grandchild ($34,000 if giving as a couple) without incurring gift taxes or using up part of the lifetime gift tax exemption.

Superfunding (five-year gift-tax averaging) lets grandparents give five times as much per beneficiary as a lump sum – $85,000 per grandchild ($170,000 as a couple) – and have it treated as though it were given over a five-year period. These estate planning benefits can be particularly valuable if the grandparents are wealthy.

Earnings in a 529 plan accumulate on a tax-deferred basis and are entirely tax-free if used to pay for qualified education expenses. Two-thirds of the states offer a state income tax deduction or tax credit based on contributions to the state’s 529 plan. (Seven states allow the state income tax break on contributions to any state’s 529 plan.)

A 529 plan that is owned by the grandchild or the grandchild’s parent is treated more favorably on the Free Application for Federal Student Aid (FAFSA) than money in a custodial bank or brokerage account. Grandparent-owned 529 plans are currently treated less favorably but this will be changing in 2024-25 and there are effective workarounds before then. Plus, nothing stops a grandparent from contributing to a grandchild or parent-owned 529 plan.

Related: 529 Plan Contribution Limits

U.S. Savings Bonds

Savings Bonds are popular among grandparents who want to help their grandkids pay for college. The interest on Series EE and Series I savings bonds purchased in 1990 or a later year is tax-free if the bonds are used to pay for college or rolled over into a 529 plan (subject to income phaseouts). 

But the grandchild must be a dependent of the bond owner to qualify for the interest income exclusion. Also, the interest rates are low. Each grandparent can buy up to $10,000 in savings bonds per year. Visit TreasuryDirect.gov for more information.

Custodial Bank Or Brokerage Accounts

Custodial accounts, such as an UGMA or UTMA account, provide limited tax benefits. The first $2,200 in unearned income, such as interest, dividends and capital gains, is taxed at a lower tax rate than parent income under the Kiddie Tax rules. The first $1,100 is tax-free and the second $1,100 is at the child’s tax rate. 

Beyond this, the unearned income as taxed at the parent’s rate. But, these accounts are reported as a student asset on the FAFSA, which will reduce eligibility for need-based financial aid by 20% of the asset value. The grandchild also gains control over the account when they reach the age of majority. The money is not earmarked for college costs. 

Roth IRA In The Grandchild’s Name

Contributing to a Roth IRA that is owned by the grandchild is worth considering if the grandchild might not be going to college. It can give the grandchild a head start on saving for retirement. Annual contributions are limited to $6,500 in 2023, subject to income limits.

If the grandchild decides to go to college, the money in the Roth IRA will not be reported as an asset on the FAFSA. But distributions will count as income, including a tax-free return of contributions from the Roth IRA. It may be best to wait until after the grandchild graduates from college to use the money to pay down student loan debt. 

Learn more about paying tuition with a Roth IRA >>>

Trust Funds

There’s a reason why this option has been placed near the bottom of the list. Trust funds almost always backfire. 

They must be reported as an asset on the FAFSA even if access to the trust is restricted. The main exception is court-ordered trusts to pay for future medical expenses.

Americorps Volunteer Awards

Grandparents could also volunteer with their grandchild through Americorps. The education awards earned by the grandparent can be transferred to the grandchild. These awards can be used to pay for college costs or repay federal student loans.

How To Help Grandkids Pay For College While They’re Enrolled

If grandparents want to help grandkids pay for college tuition, they should give the money to the parents, not the grandchild. Gifts to the student count as untaxed income on the FAFSA, reducing eligibility for need-based aid by as much as half of the gift amount. (This will be changing starting with the 2024-2025 FAFSA.) Gifts to the parent do not get reported on the FAFSA.

There is a gift tax exclusion for direct payments of college tuition under section 2503(e) of the Internal Revenue Code of 1986. Avoiding gift taxes on a direct payment is often not needed since the $15,000 annual gift tax exclusion is usually sufficient. Grandparents can also give the money by contributing it to a 529 plan for the student, even if the student is already enrolled in college.

Cosigning private student loans may be a bad idea, since the grandparent may have to repay the loans if the grandchild is unable or unwilling to repay the debt. Lending money to the grandchild or parent may also yield an uncomfortable situation if the borrower defaults. 

Such loans are not eligible for the student loan interest deduction. And if the loan is for more than $10,000, the grandparent must charge interest at a statutory rate specified by the IRS. Also, if the grandparent decides to forgive the debt, the amount forgiven will be treated as taxable income to the borrower.

A grandparent may be able to claim the American Opportunity Tax Credit or the Lifetime Learning Tax Credit on amounts paid for tuition and textbooks. But this would only be if the grandchild is the grandparent’s legal dependent (e.g., if the grandparent has adopted the grandchild).

How To Help Grandkids Repay Student Loans After College

Finally, it should be noted that grandparents can give a gift after the grandchild graduates from college to repay student loans. There are two potential benefits to this:

1. By waiting to help pay for your grandkids’ college until after they graduate, you ensure that your contributions won’t affect their eligibility for need-based financial aid.
2. Promising to repay their student loans can give your grandchildren an incentive to graduate.

Also, if there’s leftover money in a grandchild’s 529 plan, the account owner can take a qualified distribution of up to $10,000 to repay student loan debt. But note that this is a lifetime limit per borrower, not per 529 plan.