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College Savings

Q&A: Grandparent’s generosity could affect financial aid

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Dear Liz: You wrote in a recent column that grandparents could pay tuition directly to a school, and it would not trigger a gift tax return. That’s true, but my daughters have told me — and two private, expensive, and not excessively generous universities have verified — that my paying $20,000 in tuition would decrease my grandchildren’s financial aid package by $10,000 to $20,000. I would appreciate your comments.

Answer: How about, “No good deed goes unpunished — at least at private, expensive and not excessively generous universities?”

The vast majority of colleges use the Free Application for Federal Student Aid or FAFSA to determine financial need. The FAFSA was revised a few years ago so that it no longer counts cash gifts from grandparents or other non-custodial relatives. The same is true for withdrawals from 529 college savings plans owned by non-custodial relatives. Before the change, such gifts and withdrawals would be counted as untaxed student income, which had a huge negative effect on financial aid. Now, the money has no impact at all — except at schools that haven’t adopted these changes.

About 200 private colleges and universities use an additional tool, the College Scholarship Service (CSS) Profile, which can still factor in help from grandparents and other relatives. Typically, though, the maximum reduction would be 50%, not dollar for dollar.

Q&A: What can be done with unused 529 funds?

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Dear Liz: My parents set up 529 college savings accounts for my niece and nephew. The accounts are now quite substantial. My nephew chose to go to community college for his freshman year, and seems to be leaning toward not continuing in college. If he chooses to go to a trade school instead of college, can the 529 funds be used for that? Or, if he decides not to pursue either college or trade school, what becomes of those funds in his 529 account? Can they be transferred to his sister (who may not need it due to the large amount in her own account)? Is there any ability for my parents to recoup the money? What are the available options?

Answer: College savings accounts can be used at any eligible post-secondary institution, including most trade and vocational schools. In addition, up to $35,000 of unused 529 funds can be rolled tax- and penalty-free into a Roth IRA for your nephew, subject to various rules. If your nephew had student loans, up to $10,000 could be used to pay those, as well.

Your parents have many other options for unused funds. They can change the beneficiary to your niece, or any other eligible family member (which can include the original beneficiary’s spouse, children, siblings, nieces, nephews, cousins, in-laws, or parents). In addition to college expenses, 529 withdrawals can pay for up to $10,000 in annual expenses for tuition at elementary and secondary schools.

Account owners can even change the beneficiary to themselves, although they would need to incur expenses at an eligible institution to get tax-free withdrawals.

Finally, your parents could simply withdraw the money and owe income tax on the earnings plus a 10% federal penalty.

That should probably be a last resort, though. Since there’s no deadline to use the money, it can be left alone to grow for the future. Your nephew may want more education later, or your niece’s education could be more expensive than expected. Even if they don’t use the money, either or both of them may someday have kids who could use the money for their schooling.

Q&A: “Superfunding” a 529 account requires filing gift tax returns

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Dear Liz: You wrote that people could contribute up to five times the annual gift tax exclusion to a 529 college savings plan without having to file a gift tax return. People can contribute that much without the gift reducing their lifetime gift and estate tax exemption amounts, but they must file annual gift tax returns to report the gift.

Answer: To recap, few people will ever have to pay gift taxes, but gifts over the annual exclusion amount (which is $19,000 in 2026) usually require filing a gift tax return. Gift taxes aren’t owed until the amounts in excess of the annual exclusion total more than the giver’s lifetime gift and estate tax exemption amount (which in 2026 is $15 million).

Generous givers can “superfund” a 529 college savings plan by contributing up to five years’ worth of annual exemption amounts at once. In 2026, that would be $95,000. To keep the gift from counting against your lifetime limit, however, you must file gift tax returns annually to indicate the gift is to be spread over multiple years.

It’s also important to know that any other gifts you make to the same beneficiary during the five-year period will reduce the allowance for 529 gifting. And if the giver dies during the five-year period, some of the gift will be added back into their estate.

There are other rules that apply to superfunding a 529, so anyone considering this option should discuss their situation with a tax pro and likely will want to consult an estate planning attorney as well.

Q&A: How to help grandchildren pay for college

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Dear Liz: What is the best way for us to contribute to our grandchild’s college expenses? I believe federal financial aid formulas no longer count grandparents’ cash or 529 contributions. Would direct cash to the student (who is responsible) or a 529 be the most beneficial to the student or us?

Answer: If the grandchild is already in college, then cash contributions may make the most sense. The tax benefits of a 529 plan at this point would be minimal, and you’d face some restrictions in what expenses qualify.

Keep in mind, though, that you may need to file a gift tax return if you give more than the annual exclusion amount, which in 2026 is $19,000 per recipient. You won’t actually have to pay gift taxes until the amounts you give away over that annual exclusion total more than your lifetime gift and estate tax exclusion amount, which in 2026 is $15 million per person.

Any amount you pay directly to the college for tuition expenses isn’t counted toward the gift tax exclusion. (The same is true for any medical expenses you pay on behalf of someone else, as long as the payments are made directly to the medical provider.) In other words, there’s no limit on how much tuition you can pay, as long as you pay the college directly.

If college is still many years away, then 529 college savings plans are often the best option.

These plans, administered by the states, allow contributions to be invested and grow tax-deferred. Withdrawals are tax-free when used for qualified education expenses, including tuition, room and board, books and supplies, computers and related equipment and repayment of student loans.

Qualified education expenses do not include transportation costs, insurance payments or room and board above what school housing and meal plans would cost.

There’s no federal tax deduction for contributions to 529 college savings plans, although many states offer tax breaks (California and Oregon are among the states that don’t offer such incentives).

The tax breaks typically apply only if you contribute to that state’s plan, but you’re allowed to contribute to any state’s plan and use the money at nearly all accredited two-year, four-year, and graduate schools in the U.S. and many schools abroad.

Morningstar rates each plan annually.

For the wealthy, 529 plans have another benefit: up to five years’ worth of annual exclusion amounts can be contributed at once, without having to file a gift tax return. In 2026, that means you could contribute up to $95,000 per recipient.

In the past, 529 plan assets had only a small impact on financial aid, but distributions were another story. Money distributed from a grandparent-owned account was treated as untaxed income to the student, which could reduce financial aid by up to 50%.

Today’s Free Application for Federal Student Aid (FAFSA) no longer counts such distributions or any cash contributions from people other than the child’s parents. The formula also doesn’t count 529 plans owned by people other than the parents.

Such plans are still counted by the CSS Profile, which is used by about 200 private colleges, and some of the schools also count distributions. If your grandchild attends one of these schools and receives financial aid, check with the school’s financial aid office about how your generosity could affect their aid package.

Q&A: Can 529 college savings plan fund be used to study abroad?

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Dear Liz: Can my daughter use her 529 funds for summer study abroad in Costa Rica? She will be taking two Spanish classes for credit through her university. She has a minor in Spanish. Could she use the 529 for tuition, living expenses and airfare? What if it is all part of a package deal paid to her university?

Answer: Yes, tax-free withdrawals from 529 college savings plans are allowed for study abroad as long as the classes are accepted for credit by the sponsoring university and the sponsoring university qualifies for federal financial aid (the vast majority of U.S. institutions do).

Qualifying expenses can include tuition, books and supplies, plus room and board if she’s enrolled at least half time. Other living expenses and transportation costs, including airfare, aren’t considered qualifying expenses.

Q&A: Here’s something you might not know about how colleges hand out financial aid

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Dear Liz: After the pandemic started, we received money from the federal government and decided to put it in a custodial account for our son, starting when he was 14. We invested the money in a Standard & Poor’s index fund. I now think I made a mistake and should have simply added the money to the 529 college savings plan we have for him. Can I close the custodial account and transfer the money to the 529? If so, what is the process? Another benefit I see to doing so may be that the funds might not be considered in financial aid calculations. He will not qualify for aid based on need as we are financially well-off but he may qualify for aid based on merit.

Answer: You can transfer the funds from a custodial account, but contributions to 529 college savings plans have to be made in cash. That means you’d have to sell the index fund, which likely means paying a tax bill on the gains.

If your primary concern is financial aid and your family won’t qualify for need-based help, then there may be little reason to incur that tax bill right now. The merit aid you’re hoping to get won’t be affected by where you save. Merit aid isn’t based on your financial situation but is instead an incentive to attend the school and reflects how much the college wants your kid.

Need-based aid, by contrast, can be profoundly affected by custodial accounts, which are considered the student’s asset. Because 529 plans are treated much more favorably by need-based formulas, a transfer could make more sense. If there are a lot of gains in the custodial account, though, parents would be smart to get a tax pro’s advice before making this move.

With college expenses looming, consider picking up a copy of “The Price You Pay for College: An Entirely New Road Map for the Biggest Financial Decision Your Family Will Ever Make,” by New York Times personal finance columnist Ron Lieber. The book offers a comprehensive but readable guide to a fraught, potentially expensive process.