How to Help Your Grandkids Pay for College

Among the many ways you might use your wealth to provide opportunities for future generations, paying for your grandchildren's college education is surely one of the most compelling. Higher education can be a route to success, stability, and higher lifetime earnings power—but as investments go, it can be quite costly. On average, tuition at a private four-year college is more than $40,000 a year, according to the College Board. Elite schools may cost even more—and room and board push annual expenses higher still.

Laudable as the desire to help may be, planning is key, especially if gift and estate taxes are a concern. After all, if you expected to just hand over $40,000 or more each year in cash once your grandchild starts school, you would quickly start eating into your lifetime gift and estate tax exemption.

As things stand now, that comes to $13.61 million per person ($27.22 million for married couples), but unless Congress acts, the exemption will fall by half starting in 2026. Of course, you still have the annual gift tax exclusion, which allows you to give $18,000 ($36,000 if it's you and your spouse) to any individual per year without affecting your lifetime exemption. But that alone may not be enough to cover college expenses.

Fortunately, there are two great options to help fund your grandchildren's education in a tax-efficient manner.

If your grandchild is still a few years away from college, making regular contributions to a 529 college savings account may allow you to make full use of your annual gift exclusion amount every year.

You could also "superfund" a 529: You're allowed to contribute five years' worth of your annual gift tax exclusion at once, so long as you file a gift tax return and elect to spread it over the five years. That means that a couple could put up to $180,000 into a 529 for each of their grandchildren this year with zero gift or estate tax consequences. And the potential investment returns earned in a 529 account are totally tax-free if the money is used for qualified educational expenses. Be aware that contributions to 529s aren't deductible on your federal income tax, but a portion may be deductible at the state level.

People will sometimes consider saving in a minor's trust instead of a 529 account, but such trusts aren't the best option for education-focused savings. If the grandparent wants to use the annual gift tax exclusion when they fund the trust, IRS rules demand that the trust documents allow control of all assets to pass to the grandchild when they turn 21. They would then be allowed to use the funds for any purpose.

For that reason, minor's trusts can be a tax-efficient way to pay for primary and secondary education and maybe the first few years of college. However, the grandparent will no longer be able to ensure the money goes to educational purposes once the grandchild assumes control of the funds.

Normally, the IRS would recognize a large payment or purchase that benefits someone other than your spouse as a gift for tax purposes; but not so with tuition—so long as it's paid directly to an accredited educational institution. (This exemption also applies to tuition payments for private elementary or secondary schooling, and even medical expenses that are paid directly.)

Given these tax-efficient options, the right approach will be the one that best fits your and your grandkids' circumstances:

• If your grandchildren are fewer than five years from college, the best solution might be direct tuition payments. That way, you can cover their tuition expenses and provide additional support in the form of annual gifts.

  For example, if a grandchild's annual tuition is $50,000, paying that amount directly to the educational institution in each of the four years would remove $200,000 from your estate with zero tax consequences. You could then give that same grandchild an additional $18,000 a year ($36,000 from a married couple) using the annual exemption to help cover room, board, and other expenses. This could transfer an additional $144,000 out of your estate tax-free. If you have multiple grandkids, you can see how this strategy could quickly add up to significant estate tax savings.

  If you go this route, be sure your will and other estate documents set aside the funds to satisfy these commitments in case you aren't there to make the payments.

• If your grandchildren are five or more years from college, the best way to cover their education costs might be to superfund a 529 plan.

  For example, a married couple with six grandchildren could transfer $180,000 to each grandchild's 529 in 2024, which would remove more than a million dollars from their taxable estate. They wouldn't be able to make further tax-free gifts to the same grandchildren for five years. If they pass away during that five-year period, the exclusion amount for any remaining years would go back into the estate and would be taxable if the lifetime exemption is exhausted.

  Superfunding sooner rather than later could help manage the risk that tax law will change. Some tax professionals believe Congress might do away with the five-year superfunding provision in the future, though there haven't been any explicit proposals to change the rules. Still, if you're concerned the provision could go away in the future, availing yourself of it now allows you to benefit from today's law, come what may.

Whatever route you decide to take, it's wise to consult your estate planner and tax advisor to ensure your plans reflect your wishes and you haven't left any tax benefits on the table.