How grandparents can contribute to college funds instead of buying gifts

August 24, 2022

With annual tuition costs on the rise, it may be time to request monetary donations instead of clothes and toys. 

 

Kristy Esparza considers herself lucky that her mom and aunt have regularly contributed to her kids’ college education. And, while college is a long way off—Esparza’s sons are only four and six years old—the help is more than appreciated since both Esparza and her husband are still paying off their own student loans, which they consolidated four years ago.

“We’re grateful for each and every monetary contribution,” says Esparza, founder of JJ and the Bug, a family travel site based in San Jose, Calif. “Unlike toys that kids grow out of after a few months, my mom knows this gift will impact the kids for the rest of their lives.”

If you factor in 18 years of birthdays and at least 18 holidays, there are so many opportunities for family members to help contribute to paying for college, says Patricia Roberts, author of "Route 529: A Parent’s Guide to Saving for College and Career Training with 529 Plans," who has spent over 20 years educating families about how to prepare for higher education expenses.

With consistent contributions, those college accounts can quickly accrue value.

“If over 18 years 10 close friends and family members give just $25 toward your child’s college education annually for each of two special occasions, your child could have over $14,000 for college, assuming an estimated annual 5% rate of return,” Roberts says. “If 10 friends and family gave $50 on each occasion, your child could have $28,000, and so on.”

If you’re worried about asking your or a partner’s parents to contribute to a college fund, keep in mind that most people are happy to do so. “Parents can typically expect favorable responses,” Roberts says. One of the most natural ways for you to put this out there is when you’re asked what type of presents a child would like for an upcoming birthday or holiday.

And for grandparents who are completely opposed, “hopefully they will understand that the suggestion was based on a genuine desire to make the future brighter and less financially stressful” for the grandchildren, Roberts says. “Given the high cost of college and outstanding student debt of $1.75 trillion in the United States1 … there should not be any hard feelings about your invitation to have others who love your children consider an alternative gift idea that is easy to give and can grow with the child.”

When you’re ready to broach the ‘skip-the-gifts-in-favor-of-helping-pay-for-college’ topic with the grandparents in your life, start by explaining these five popular options:

 

Option #1: Utilize a 529 college savings plan


There are a number of valuable ways that grandparents can utilize a 529 college savings plan to help with a grandchild’s higher education goals. While the grandparent can set up their own 529, they can also contribute to a 529 plan owned by a parent of the grandchild, Roberts says.

  • Pros: Most 529 plans make it easy for account owners to invite others to contribute to them. Additionally, recent changes to the Free Application for Federal Student Aid (FAFSA)—anticipated to go into effect for the 2024-25 school year—mean that 529 contributions will no longer impact a student’s financial aid eligibility. 529 funds can also be transferred to another eligible family member, like a sibling, which offers some flexibility if the first child decides not to attend college, for example, or gets an excellent scholarship and only needs a portion of the designated money. Grandparents could also front-load contributions and make up to five years of annual gifts in one year ($15,000 each per year totaling up to $150,000). This larger gift wouldn’t be subject to the gift tax if the grandparents live for the full five years. This can be an effective estate planning strategy, since 529 plan assets are exempt from federal estate tax.
  • Cons: One downside is that with a 529 plan owned by someone else, the grandparent loses control of the funds once contributions are made. “For example, the gift giver can’t direct how the contribution is invested or when it is withdrawn because they are not the owner of the account,” Roberts says. “After the grandparent’s contribution is made, complete control of the account rests with the account owner (which is often the grandchild’s parent) and that individual can change the beneficiary or withdraw funds at any time.” Also, these funds can only be used for qualified educational expenses such as tuition, textbooks, school equipment and certain room and board fees.

 

Option #2: Pay the college or university


One easy option for grandparents is to make payments directly to a grandchild’s college or university.

  • Pros: This is a straightforward approach that can give a grandparent both certainty and pride in knowing exactly how their funds are being used. “Another positive is that tuition payments made directly to a college aren’t subject to the annual federal gift tax exclusion,” Roberts says, noting that this exemption is limited to tuition only (not room and board or other expenses). “As a result, grandparents who have the means to do so can still give a grandchild a gift of up to $16,000 in 2022 tax-free in addition to making these tuition payments.” 
  • Cons: It’s possible that your grandchild may receive less need-based financial aid in light of the direct payment. “Before a grandparent makes a direct payment, students should check on their eligibility for institutional aid and the impact a grandparent payment may have on it,” Roberts says. Furthermore, since you’re paying the college directly in the moment—versus putting the money aside when the kid is still young and allowing it to grow for decades—this option doesn’t allow you to benefit from an annual rate of return and the tax benefits of owning a 529 account.

 

Option #3: Loan your grandchild money


A grandparent can simply give their grandkid a loan to cover education expenses. 

  • Pros: The grandparent and grandchild can decide on the terms of the loan. Plus, a loan of $10,000 or less is exempt from IRS rules and can be made interest-free, Roberts says.
  • Cons: For loans above $10,000, IRS rules must be followed carefully, including, but not limited to, the imposition of a minimum interest rate. “In addition, the interest earned on the loan will be taxable to the grandparent and can’t be deducted by the grandchild,” Roberts says. “Also, if a grandchild decides not to repay the loan, it can create major stress within the family.”

 

Option #4: Establish an education trust


Grandparents may wish to create an irrevocable trust for the specific purpose of funding a grandchild’s education. 

  • Pros: Grandparents can specify their specific intent in a trust document—for example, stating that the funds must be used for college-related costs—knowing that the trustee is required to follow the grandparent’s wishes. “Even after a grandparent’s death, a trustee has a fiduciary duty to follow the trust’s terms, which may provide a grandparent with comfort,” Roberts says. 
  • Cons: Unlike contributions to a grandparent-owned 529 plan, which can be withdrawn by the grandparent if needed, a grandparent’s contributions to a trust are irrevocable, Roberts says. “Additionally, it can be costly to establish and maintain a trust, and trust income will be taxed at a high rate,” she adds. 

 

Option #5: Consider U.S. Savings Bonds 


A grandparent might prefer to purchase U.S. Savings Bonds to help contribute to a grandchild’s education.

  • Pros: These are incredibly easy to purchase online and provide guaranteed interest when they mature—but note: that can take years. “One benefit is that when they’re used to cover costs associated with higher education, certain bonds may be redeemed tax-free,” Roberts says.
  • Cons: Interest rates on savings bonds are low in comparison with other forms of saving or investing. “That’s one of the big downsides grandparents should consider when seeking ways to help fund higher education costs,” Roberts says.

 

Learn how funds from 529 plans can be used for qualified K-12 tuition costs, in addition to paying for college expenses.

Related content

How to open and invest in a 529 plan

Parent checklist: Preparing for college

Your financial aid guide: What are your options?

1 Student Loan Debt Statistics: 2022, NerdWallet.
 
For more information regarding college savings plans, please visit www.collegesavings.org.  Participation in a 529 plan does not guarantee the investment return on contributions, if any, will be adequate to cover future tuition and other higher education expenses.  Before investing in a 529 College Savings Plan, consider your state of residence, which may offer a 529 College Savings Plan with state tax or other benefits available only to residents of the state.  Federal income tax on the earnings and a 10 percent penalty on distributions for non-qualified expenses may apply. 
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