College Aid: The Rules for Grandparents

Photo by Ron Chapple

With the price of a college education often surpassing the cost of a luxury car—sometimes even a house—parents today need help. Sometimes it’s the grandparents who are willing to pitch in.

But grandparents who want to see a grandchild graduate without debilitating debt must be careful that their generosity doesn't backfire. Well-intentioned givers can sabotage their own efforts if they don't understand the rules. Here are the ones to follow:

Ask before mailing a check. You may think that the most obvious way to help a grandchild is to mail money directly to a college tuition office. You can write a check of any amount to a college to pay for expenses without filing a federal gift tax return. You'll be wasting your money, however, if the university reduces your grandchild's financial aid package by the amount of your largesse. To prevent this fiasco, ask the school in advance whether a contribution would jeopardize any financial aid your grandchild may be receiving.

Beware of other financial aid busters. Making direct payments isn’t the only financial aid no-no, observes Mark Kantrowitz, the founder of FinAid, a comprehensive source of information on college funding options. He counsels families who think they might be eligible for aid to “avoid custodial accounts, saving bonds in the kids' own names and trust funds.” All these savings vehicles can hurt a family’s chances for receiving need-based aid.

Save with a 529 plan. Grandparents typically won't jeopardize a child's chances for financial aid by investing in a 529 college savings plan. The federal formula for determining aid doesn't ask about 529 accounts owned by grandparents.

"In my opinion, 529 plans were really made for grandparents," says Joe Hurley, founder of Savingforcollege.com. "They do not impact financial aid and they don't allow the grandchildren to get their hands on their money. The grandparent stays in control."

Be patient. Monetary gifts to your grandchild must be reported on financial aid applications. If your family definitely won’t qualify for aid, handing cash directly might be fine. But if financial aid is a possibility, you could delay writing a check until the spring of your grandchild's junior year in college. By that point, your family will have filed its last financial aid form.

Coordinate giving. Some savings accounts impose contribution limits, so communication is a must. For instance, the yearly ceiling for contributions to a Coverdell Education Savings Account is $2,000. Coverdell contributions from all sources—grandparents, parents or others—can't surpass that yearly $2,000 mark. However, there is no limit on the number of separate Coverdell accounts one beneficiary can have. For more information, go to www.irs.gov/publications/p970/ch07.html.

Lynn O’Shaughnessy is a financial journalist based in California.