Prime Montgomery
January 31, 2015

By Alan Wallace

A recent survey by Fidelity Investments found that 53% of grandparents plan to help pay their grandchildren’s education costs. Grandparents are pitching in for numerous reasons. More families are opting for private primary and secondary education, post-secondary education costs have risen sharply in recent years, loans instead of grants comprise most financial aid, large student debt loads can be a long-term burden, and parents are often unable to shoulder the entire expense of educating their children. In this environment many grandparents are willing to play a practical role in helping the youngest members of their family.

Good decisions about assisting are based on understanding the pros and cons of various choices. Having general information before considering specific options may speed up the process and help avoid unpleasant surprises.

Remember, though, that your first responsibility is your own needs. Realistically assess your own requirements and resources, not only now but for the future, before committing to help. Finding yourself short of money later because you helped your grandchild might create bigger challenges for your family than the education issues. It is also important to avoid using money as a relationship management tool. If you decide to assist, the following information can help you formulate a plan.

Primary and Secondary (K-12) Education
If private school for K-12 is in your grandchild’s future, the avenues for assisting are limited. The simplest way is to write the school a check. This avoids gift tax questions. If you prefer, you can give money to the child’s parents. Gifts in excess of $14,000/recipient could be subject to federal gift tax.

If the child is not old enough to attend and you want to get a head start, one tax-advantaged plan is available. Called a Coverdell Education Savings Account (ESA), it allows for annual cash contributions of $2,000 to an account for a single beneficiary from all sources. In other words, if more than one person will be adding money to an ESA for little Johnny, all donors must coordinate their giving to avoid exceeding the $2,000 annual maximum.

While ESA contributions are not deductible, income taxes are not levied on appreciation of the assets in the account. If you have a newborn granddaughter and fund the ESA at the maximum level until she starts school, you may achieve a little tax-sheltered growth before the money is needed. Funds withdrawn from the account to cover K-12 or post-secondary costs are generally not subject to income tax.

However, given the cost of private K-12 education in our area, the benefit available from an ESA is pretty limited. Furthermore, ESAs carry other constraints:

  • Donors are subject to an income limitation.
  • You cannot establish an account until the child is born.
  • You cannot add to it after the child reaches age 18.
    • Any remaining balance must be withdrawn by the child by age 30.

Post-Secondary (College, Vocational & Post-graduate) Education
With few exceptions the cost of post-secondary education falls mainly on the student and his family. Advance planning and pre-funding can make the burden more manageable.

Twenty years ago the options for accumulating college funds were quite limited. Among the most common was a taxable account set up for that purpose. The account would either be in the name of an adult (a parent or grandparent of the student) or in the name of the student as a UTMA/UGMA account (Uniform Transfer to Minors Act or Uniform Gift to Minors Act). Like most states, Alabama has a UTMA statute allowing assets held for the benefit of a juvenile to be controlled by a single custodian until the child reaches majority age. In Alabama, that is age 19, at which time the child gains full legal control of the assets. Since 19-year-olds do not uniformly make rational decisions, UTMA accounts carry clear risks.

Fortunately, Congress created a pair of new options about 20 years ago. Section 529 of the Internal Revenue Code provides for two kinds of post-secondary funding accounts or qualified tuition plans: prepaid tuition plans and savings plans. Keep in mind that neither plan guarantees a student admission to any school. One of the best sources of information about both types and the available options is (A great site for comparing schools and their costs is

Prepaid Tuition Plans
Generally offered by state governments, residency in that state may be necessary to participate. Federal law does allow individual institutions to set up a plan, but none have done so. One plan, the Private College 529 Plan, is available from a consortium of more than 270 private schools.

State-sponsored prepaid tuition plans are intended to keep pace with the cost of tuition, usually based on an average of the state’s public colleges and universities. Benefits include favorable tax treatment. If the student attends an out-of-state or private school, the plan will generally pay out based on the average of in-state public school costs at the time the student is enrolled. These plans usually cover just tuition and basic fees, not room and board, books, etc.

The plan is controlled by the owner, not the child, and is transferable to another member of the family if the child does not use the plan. A prepaid plan falls into one of two classifications: a prepaid contract plan (prepay for 1-5 years of tuition) and a prepaid unit plan (prepay for units that equate to credits or hours of instruction).

If this program sounds familiar, it may be because the Alabama PACT (Prepaid Affordable College Tuition) program was a prepaid tuition plan. This program has been closed to new accounts since 2008. One lesson from the demise of AlaPACT that could extend to other prepaid tuition plans is that disappointing investment results and rising tuition costs might prevent them from meeting enrollees’ expectations.

Section 529 College Savings Plans
Now holding more than $200 billion, 529 savings plans have become the preferred method for accumulating funds over the past decade for post-secondary education. Most plans are offered by individual states and may be purchased directly or through a licensed broker who may be paid a commission. Here is a brief summary of the main features and benefits of these plans.

Tax benefits – Although contributions are not deductible for federal purposes, investment gains inside the plan and withdrawals used for qualified expenses are not subject to federal income tax. Most states afford similar treatment. If the student qualifies for a scholarship, funds withdrawn are not subject to the penalty which usually applies to a non-educational withdrawal.

Covered costs – Qualified expenses include books, room and board, in addition to tuition and fees.

Control – The account is controlled by the adult custodian, designated by the donor, not by the child.

Transferability – The beneficiary (student) may be changed to another member of the family, with fairly wide latitude. No age-related deadline forces funds to be withdrawn; a remaining balance could benefit a later generation.

Deposit and balance limits – There is no income cap for funding a 529 savings plan. The amount you contribute is more likely to be limited by your circumstances than by tax law or the rules of the particular program you select. If you plan to make large contributions, consult with your tax advisor about possible gift tax consequences and appropriate planning, and check the rules for the plan you want to use.

Flexibility – You may use a plan sponsored by any state (or multiple plans in multiple states). Funds may be moved from one 529 program to another without federal taxation, although state taxes or benefits may apply in some instances. You may choose from any of the investment choices offered by the plan(s) where you open an account.

Your choice of a particular plan, of which there are dozens, should be based in part on these important considerations:

Contribution and balance caps – Plans set limits on contributions or plan balances. Choose one that fits your needs and goals.

Expenses – Compare plan expenses. Lower costs can help your money deliver more education.

Investment choices – Each plan offers its own investment options. In some cases the choices are those of a single investment organization; in others the plan “cherry picks” options from an array of managers.

State tax benefits – Some states offer tax benefits to in-state residents using their plan. For instance, Alabama residents may deduct up to $5,000 per taxpayer annually for contributions to the Alabama CollegeCounts 529.  A couple filing jointly can deduct $10,000/year and save up to $500. In fact, Alabamians can get this benefit on a transfer from another state’s plan.

According to Alabama State Treasurer Young Boozer, “The Alabama CollegeCounts 529 is the best way to save for your grandchild’s college education. No doubt about it. The program has grown dramatically over the past four years.  We now have $1.2 billion of assets under management and accounts have increased to 71,000.  We encourage account holders that have 529s from other states to rollover their accounts to CollegeCounts for the tax benefits available to Alabama taxpayers.”

Final Thoughts
If you decide to help with educational costs, here are five final items to keep in mind.

1) Have a conversation with the parents of the child(ren) you plan to help. Coordination generally improves the outcome. The potential benefits of consulting with your child and her spouse include improved relationships, better choices about what plan(s) and investment option(s) to use, and a seamless transition if something happens to you.

2) If you plan to assist multiple grandchildren, opening a single aggregated account may have benefits. Maintaining separate accounts for each child may do nothing but complicate your life and increase fees, until you need to segregate money for a child enrolling in college or the account balance reaches the program’s maximum.

3) If you use a single account for the benefit of grandchildren by more than one of your children, retain control and make sure that your will prescribes how the account is to be divided if something happens to you.

4) If you use a single account, name the youngest grandchild the beneficiary until the older ones have applied for financial aid. This reduces the risk of having assistance withheld from the older ones because they appear to have a big 529 balance.

5) Do not vastly overfund a 529 account since a 10% penalty applies to earnings (not principal) withdrawn for non-qualified expenses.
Post-secondary education provides many benefits, including improved employment prospects and higher income potential. If you choose to help your grandchildren reap these rewards, a well-designed plan can leverage your investment in their future.

Alan Wallace, CFA, ChFC, CLU is a Senior Financial Advisor for Ronald Blue & Co.’s Montgomery office, He can be reached at 334-270-5960, or by e-mail at