

By James A. Spella and Elliot Depies, Schloemer Law Firm, S.C.
Many grandparents and relatives want to support a grandchild’s or family member’s education by contributing to a college savings account. Universities continue to raise tuition prices and the cost of living rises along with it. Fortunately, changes have been made to 529 accounts that allow for increased giving and even the ability to plan for retirement.
For Wisconsin families, there are two alternatives: Edvest 529 and Tomorrow’s Scholar, which will be discussed in this article. Schloemer’s experienced estate planning attorneys, headquartered in West Bend, Wisconsin, are available to discuss gifting for education and which method is best for your family, whether it be direct annual gifting, setting up an education trust, or using a 529 plan.
How do I help pay for my grandkid’s college?
There are various ways you can contribute to a grandchild’s education, including directly gifting money to them or their parents, funding a trust, or investing in a 529 account.
- Direct Gift or Funding a Custodial Account
Gifting is perhaps the simplest way to pay for education: just give the money to them in some direct manner. This can be quick and straightforward, but this technique has drawbacks. For example, once funds are gifted to them, you no longer have any say over what those funds are used for.
If a gift exceeds the tax-free annual gifting limit of $18,000 per person, a donor (grandparent) will need to file a gift tax return reflecting the amount over $18,000. This can have estate tax implications, as large gifts will eat up part of your lifetime unified tax credit, which is a concern for large estates. However, if you are married, you and your spouse can each gift up to $18,000 tax-free, so a total gift of $36,000 can be made without incurring the need to file a gift tax return.
The tax-free annual gifting limit also applies when funding custodial accounts. The funds can be used for a wider variety of things than say a 529 plan, but custodial accounts do not have the tax advantages of other types of accounts. For example, withdrawals on earnings are taxed, unlike a 529 plan.
Whether directly gifting to a grandchild or funding a custodial account, the funds would be considered countable assets in the determination of financial aid with impacts on the FASFA, which could actually end up costing your grandchild money.
Making payments directly to an educational institution is another way to make a direct gift. The benefit of this is that the payment qualifies for the educational exclusion under section 170(b)(1)(A)(ii) of the Internal Revenue Code (IRC) and therefore does not use up the $18,000 annual gift tax exclusion. However, the payments can only be for tuition—payments for things like room and board would not qualify. For example, a grandparent could pay $20,000 to a university for tuition and then also give the student $18,000 in the same year without incurring federal gift tax.
- Funding a Trust
Trusts are a powerful tool that are used in many different ways in business and estate planning. They can also be used to help fund an education. Depending on how a trust is set up, the grandparents may or may not be able to take advantage of annual exclusion gifting.
Grandchildren’s Trust. The main drawback with utilizing a standard Grandchildren’s Trust that is limited solely to education is that funds transferred into the trust are normally not considered a “gift of present interest,” meaning that the donor cannot count the first $18,000 as gift-tax free, and the donor will have to file a gift-tax return, using part of the donor’s lifetime unified tax credit.
2503(c). Grandparents can establish what is referred to as a “Section 2503(c) trust” to have the first $18,000 transferred into the trust considered a tax-free gift so long as the beneficiary is under 21 years old. The trust funds are not considered a part of the donor’s (grandparent’s) estate, shielding it from the federal estate tax upon death. The trustee, however, has the ability to use these funds for anything he or she deems necessary for the beneficiary (grandchild), which may not include paying for education. For example, the trustee could use funds for education, a vehicle, housing, medical bills, or other support of the beneficiary.
2503(e). Relatedly, a Health and Education Exclusion Trust (or “HEET” Trust) is a dynasty-type trust that is intended to directly pay health (medical) and education (tuition) expenses. This Trust is created pursuant to Section 2503(e) of the IRC. If trust funds are used exclusively for tuition, this method can avoid Generation-Skipping Transfer Taxes (GSTT), but any balance left once the trust is terminated (say, when the student no longer is paying for college) must go to a charitable organization. Additionally, if it is set up as a grantor trust, it will not be subject to income tax. In short, HEETs are an effective way to pay for tuition and medical expenses while avoiding the generation skipping transfer tax, but grandparents should be careful to not overfund these trusts as their distributions can only be used for certain purposes, and the ultimate beneficiary must be charitable.
Donors should also be aware that trusts have compressed tax rates, which would curtail the overall tax savings and essentially penalizes trusts that accumulate income.
- 529 Plan
Funding a 529 account is one of the best ways to help pay for a grandchild’s education, particularly with the recent changes instituted by Congress. This type of account is a creation of the IRS, and its name comes from the code section it is under—26 U.S.C. 529. It is a state-sponsored tax-advantaged saving/investment account.
Wisconsin has two types of these plans: Edvest 529 and Tomorrow’s Scholar. Edvest 529 is direct-sold while Tomorrow’s Scholar is advisor-sold. They both have the benefits and drawbacks listed below.
There are a host of benefits from using this type planning:
- Accelerated Gifting. You can contribute up to 5 years’ worth of gifting in one lump sum without triggering the federal gift-tax return filing requirement. This would allow 5 years’ worth of invested funds to start growing right away; otherwise, to avoid paying taxes, a donor would have to wait until a new tax year to give the next $18,000. That $18,000 would grow for one fewer year and the amount by the time the grandchild goes off to college would be smaller than if the grandparent had contributed 5 years’ worth right away. With the current gift-tax exclusion at $18,000, this means an individual can contribute up to $90,000, or, for a couple, $180,000, right away. There is no minimum to contributions however, so you may fund this with as much as is affordable for you; just keep in mind that exceeding the annual gift-tax limit or that one time 5-year lump sum amount will have tax consequences.
- Tax Free Growth. If these funds are used for qualified higher education expenses, earnings in the account are not subject to federal income tax and in most cases state income tax.
- Estate Tax Reduction. Funds will not be considered a part of the donor’s estate, potentially decreasing federal estate taxes.
- It used to be that distributions from a 529 would likely reduce the student’s financial aid, and people were concerned that left over money would be trapped or taxed. For example, the old FASFA treated non-parent owned 529s as untaxed income, reducing the student’s eligibility for need-based aid. But now, the FASFA only calculates a student’s income based on federal tax returns, so cash support, like from a 529, will not negatively impact a student’s financial aid eligibility.
- Transfers to other Family Members. If there is money left over, there are multiple beneficial ways to continue to support your grandchildren’s future. Firstly, the 529 can remain in existence and the beneficiary can be changed to a sibling, first cousin, or other family member as directed by the IRC. Secondly, the funds can be rolled over to a Roth IRA.
- 529 to Roth IRA Roll Over. A big change has come with the SECURE 2.0 Act and its impact on Roth IRAs. Starting January 1, 2024, left over funds up to $35,000 can be rolled over into the grandchild’s Roth IRA. Roth IRA income limitations are waived for 529 rollovers. These rollovers also do not incur Wisconsin state tax. There are some rules in doing this, however, including but not limited to: (1) the account must have been open for 15 or more years prior to the date of rollover, (2) the 529 beneficiary and Roth IRA owner need to be the same person, and (3) rollovers must be trustee-to-trustee, meaning you cannot withdraw money from the 529 and then deposit it into the Roth IRA—you must file a form to transfer it directly.
- Tax Deduction. Wisconsin residents can also reap tax benefits from contributing to a 529. The first $5,000 contributed per beneficiary per year is eligible for gross income exclusion, meaning you can count that contribution as a tax deduction on your state income taxes.
Drawbacks/Penalties
- If the funds are withdrawn and not used for qualified higher education expenses, there is a 10% penalty in addition to the taxes that will then be levied against it. This is why it is important to remember that the beneficiary may be changed to certain family members and that the funds can be rolled over to Roth IRAs.
- Like many investment accounts, you may be charged fees for someone else to manage the 529 and invest the funds. Also, even very safe investments like 529s can go bad, and the account may not grow or in the worst case scenario lose value.
What can these funds be used for?
“Qualified higher education expenses” include tuition, certain room and board expenses, fees, books and supplies, and even some technology expenses like software and printers while the student is enrolled at an eligible institution.
“Eligible institutions” are accredited public or private universities, colleges, technical colleges, community colleges, graduate schools, and apprenticeship programs registered and certified with the Secretary of Labor under the National Apprenticeship Act.
These funds can even be used for K-12 schooling tuition up to $10,000 per taxable year.
As of 2019, $10,000 from 529s can be used to pay back student loans.
Additionally, expenses for special needs services in connection with enrollment or attendance at an eligible institution can be covered by funds from a 529.
Conclusion
There are many ways you can contribute to a grandchild’s education. Doing so in a tax-efficient manner that best supports your loved one will take some planning. Some of the most prevalent ways are direct gifting, establishing a trust, and utilizing a 529 account. There are pros and cons for each; deciding which method to use will depend on each individual’s financial situation and wishes.
Questions?
Contact this article’s author to discuss your plans to contribute to your grandchild’s or family member’s education. Schloemer Law Firm, S.C., helps clients with their estate planning, business, probate, and real estate needs, particularly for the communities of Washington, Fond du Lac, Milwaukee, Dodge, Sheboygan, and Ozaukee counties.
Originally published: October 9, 2024.
More Important Reading
- Giving the Gift of an Education
- Estate Tax Cliff
- Wisconsin Nursing Home Care Planning: Long-Term Asset-Protection Strategies
- Estate Planning for Mixed Families and Second Marriages
- Your Family Business Succession Plan
Disclaimer: The information contained in this post is for general informational purposes only and is not legal advice. -Due to the rapidly changing nature of law, Schloemer Law Firm makes no warranty or guarantee concerning the accuracy or completeness of this content. You should consult with an attorney to review the current status of the law and how it applies to your unique circumstances before deciding to take—or refrain from taking—any action. If you need legal guidance, please contact us at 262-334-3471 or [email protected].
