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How to Help Your Grandkids Pay College Expenses

May 27, 2015

Rising tuition fees at colleges may take many parents by surprise. Even if they have been saving for their children’s college education, they may find that it’s not enough. According to a report, college tuition and fees account for only about 40% of the total expenses incurred by in-state students for a four-year college education. Even if the student takes a part-time job, the cost of college is often too burdensome to pay.

Grandparents that have more to spare after retirement can consider helping their grandchildren pay for their college expenses. Instead of giving them a check or handing over cash, there are tax-efficient ways to make a contribution. Richmond Times explains:

The most effective way to help your grandkids is to invest in a 529 college savings plan. Sponsored by 48 states and the District of Columbia, 529 plans provide a tax-efficient way for grandparents to help with college costs.

Earnings on investments grow tax-free, and withdrawals aren’t taxed as long as the money is used for qualified expenses, including tuition, fees, and room and board. If you withdraw money for non-qualified expenses, you’ll owe income taxes and a 10 percent penalty on the earnings.

In addition to tax-free growth on your investment, you could get a tax break on your contributions. Thirty-three states and the District of Columbia offer deductions or other tax benefits for contributions to a 529 plan.

Virginia residents can deduct up to $4,000 in contributions to their state’s 529 plan from their state income taxes each year, with an unlimited carry forward to future tax years. (Residents over 70 can deduct the entire amount of their contribution.)

Most states require you to invest in-state to claim the deduction, but six states — Arizona, Kansas, Maine, Missouri, Montana, and Pennsylvania — will give you a tax deduction for investing in any state’s 529 plan.

Unlike other education-savings vehicles, 529 plans have high contribution limits: Most plans allow you to invest $300,000 or more per beneficiary. And you can contribute to the plans no matter how high your income. But you’re limited to the investments offered by the plan, and you can change investments only once a year.

Money held in a grandparent’s 529 plan isn’t counted as an asset on the Free Application for Federal Student Aid (FAFSA), which is used to determine a student’s eligibility for financial aid. But when you take withdrawals to pay for your grandchild’s college expenses, those distributions are treated as the child’s income on the following year’s FAFSA, reducing financial aid on a dollar-for-dollar basis.

To get around this problem, you could wait to withdraw money from the 529 plan until your grandchild is a college junior and has filed the FAFSA for the last time. Or consider switching ownership to the child’s parents.