Spoiling the grandkids with back-to-school shopping is one of the joys of being a grandparent. But the thrill of new clothes, notebooks, and gadgets can only do so much to offset the sobering arrival of the semester’s tuition bills.

For grandparents who want to help with this other, decidedly less joyful aspect of back-to-school – education funding – the possibilities are many. Unfortunately, so are the pitfalls.

Pop Quiz

“What can I do to help my grandchildren afford a good education?” On the face of it, it seems to be a straightforward question, and for some families it is.

However, if you’ve got 10 grandkids and you’re far from confident in your own retirement security, experts advise caution:

“I never want to see a newly-retired grandparent with anything less than a 100% solid financial position give,” commented Melinda Davis, CFP®, CRPC®, of Bedford, NH-based Davis Wealth Advisors.

Like the oft-repeated pre-flight safety reminder to secure your own mask first, this may be difficult advice for some grandparents to follow. But what grandchild wants to find out somewhere down the line that his diploma cost Grandma her house? As with airline safety, it’s best to make sure you’re in good shape yourself before helping others.

At the other end of the spectrum, let’s say little Emily is the only child of your only child, and she’ll never qualify for financial aid. Money-wise, you’re set for life and then some. You’re in a position to help as much as you want, however you want.

Trick(y) Question

If you’re like most, your family falls somewhere in between, both in terms of number of grandkids and financial situation. For you, financial aid, income tax, and gift/estate tax laws combine to create myriad opportunities to get the most bang for your education buck. Equally numerous are the intricacies and interdependencies between these systems.

But don’t let that deter you! Planning your giving can make an enormous difference in how much of your money ends up helping the apple of your eye, versus being diverted to Uncle Sam or somebody else’s grandchild’s financial aid award. How enormous?

Timothy M. Hayes, MBA, CFP®, of Landmark Financial Advisory Services, LLC, in Pittsford, NY, cites this example. “Suppose the grandchild receives a $5,000 financial aid package, and the grandparents want to step in to cover the $35,000 difference between that and the year’s total cost. Depending on when and how they do that, the family could lose up to 100% of the financial aid.”

You read that right. In their attempt to defray the family’s costs, these grandparents might inadvertently have lost the entire $5000 in outside help, putting them right back where they started. “True, it might only be loans or work study, not grants. But if their help is costing the family any kind of free money, the grandparents need to be sensitive to that,” Hayes counsels.

Do Your Homework

So it pays to do your homework — maybe even more so for you than the parents, i.e. your kids. Yes, you have many of the same education funding options, but unlike the parents:

1. You are not eligible for income tax credits and deductions on education expenses (unless your grandchild is a dependent.)

2. Your situation does not factor into financial aid assessment until money actually goes to the grandchild or his parents.

3. If more than one of your kids has kids, it might be advantageous to take a different approach with each family.

4. With more of life behind you, you may have greater insight into your retirement security and estate plan.

The financial planning implications are unique to each situation:

• Grandchild – age, education goals, and family’s personal finances

• Your finances – net worth, types of accounts, other resources

• Your stage of life – working or retired, taking Social Security, pension, or required minimum distributions (RMDs)

Lesson of the day? Things can get tricky. In a game with so many moving parts, the perfect solution for one family can be a costly mistake for another. And that’s before you consider “soft” factors like fairness, family dynamics, and agendas (hidden or otherwise.)

Plan Not To Cram

That’s why even if it’s too early to start saving and giving, it’s never too early to start planning. Rule of thumb often doesn’t apply, and the math doesn’t always work the way you think it will. The stakes are high. So before you pull out your checkbook, invest the time and money to engage a qualified financial advisor and map out a plan.

For grandparents who are ready, one education savings vehicle to consider is the Coverdell Education Savings Accounts (ESA). Many financial advisors have moved away from ESAs due to their low income and contribution limits. But Elaine Webb, CFP®, EA, of Elaine Webb Financial in Roseville, CA, still sees a place for them, particularly for families with modest means and education goals.

A grandparent who saves the ESA maximum $2,000 a year when the grandchild is born can amass $36,000 plus earnings by the time college rolls around. For a kid living at home stockpiling credits at a community college or state school, that meets a good portion of the need. Not only that, but ESA accounts aren’t just for college. They can also be used to fund elementary, secondary, or special needs education costs.

While ESAs offer flexible use of the money, their value is limited for families with the means to save more. “Most clients want things simple,” observed Davis. This often leads them straight to 529 plans. Grandparents wishing to “set it and forget it” can take advantage of age-based investment options typically offered by 529s. And it’s nice to know that, if little Sophia gets a full scholarship, Grandma can change the beneficiary on her 529 plan to sister Ava or cousin Liam.

Still, tax expert Webb advises clients: “Don’t put more than is projected to cover half the cost of college into a 529.” Overfunding college sounds like a nice problem to have. But it puts account owners in a position of having to pay taxes and, with a few exceptions, a 10% penalty on money withdrawn but not used for college. Grandparents would be wise to coordinate with parents holding their own 529 accounts to avoid this.

Coordination of contributions is even more critical for ESA accounts, cautions Hayes. That’s because, unlike 529s for which contribution limits are on a “per account” basis, ESA contribution limits are on a “per student” basis.

Grandparents who are still working and want maximum flexibility with the use of the money should consider saving to a Roth IRA. Even though a Roth is technically a retirement account, its unique tax characteristics lend it to use as a dual purpose savings vehicle.

So if the grandchildren need help paying for school and you can spare the money, you can always withdraw Roth contributions tax and penalty-free for this or any purpose. Depending on your age and other factors, the same may be true for earnings on the account. Just be sure that, when deciding how to invest it, you take both college and retirement goals and timelines into consideration.

Don’t Hand It In Early

Saving money is only part of the curriculum for grandparents who want to make the most of their education funding for their grandkids. The next phase calls for smart distribution of these assets. And the watchword for most grandparents is “wait”. Webb says, “Everything points to holding off on giving until junior or senior year.” Not only does it afford the grandparents time to gain greater confidence they won’t need the money, it also creates an incentive for the grandchild to finish school.

For many families, the best reason to wait is financial aid eligibility. Per a recent change in the laws, eligibility is based on the family’s tax return from 2 years prior, no longer the previous year’s. This means grandparent giving in the latter half of a 4-year program does not reduce aid.

If your grandchild needs help with college costs before junior year, Hayes suggests loaning them the money instead of giving it. “But it has to be a bona fide loan,” he notes. Once the student is past concerns about financial aid eligibility, you have the option to forgive the loan up to the amount of the gift tax exclusion each year.

Hayes hears from clients who give their grandchildren money for college each year as part of their gifting strategy. While well-intentioned, this strategy might not be helping as much as it could, if the grandchild may someday be eligible for financial aid. For these clients, he recommends funding a 529 instead of giving directly.

Income taxes can also dramatically affect how much benefit you wring out of your education funding dollars. “Grandparents should pay special attention to which assets they tap to help with education costs,” says Davis.

In particular, withdrawing from tax-deferred retirement accounts could result in an unexpectedly high tax bill and possibly a jump into a higher bracket. Here’s another case where planning ahead for later giving – for example, withdrawing or converting 401k assets to Roth IRA money incrementally in the years before it’s needed – can make a big difference.

Summary Cum Laude

Figuring out how to make the most of your money might not be as much fun as hitting the back-to-school sales. But it’s true what they say: if you think education is expensive, try ignorance… of education planning. With a little studying, a little strategizing, and a little guidance from an experienced counselor, you and the grandkids will both be passing with flying colors.

Looking for a place to start? Here are all the advisors on the GuideVine network who specialize in financial planning for education.

Sherrill St. Germain

Sherrill St. Germain

Sherrill St. Germain, MBA, CFP®, is a freelance writer specializing in financial independence. A former fee-only planner, she brings a decade of financial planning experience to content she develops for financial professionals, publications, and her blog TheFISide.com Follow Sherrill St. Germain on Twitter.