Saving for a grandchild’s education is a meaningful gift that can make a lasting impact. As the saying goes, ‘knowledge is power.’ However, when it comes to opening a 529 College Savings Plan, there are considerations to be mindful of.
There are two ways you can help your grandchild save for and pay for college expenses through 529 plans. You can contribute to an existing 529 account If the child’s parent(s) already owns one, or you can open a new account for the benefit of your grandchild yourself.
Being the owner of the 529 account gives you control over the assets. The primary advantage of this approach is the ability to ensure the money will be used for education, which it should be. If a distribution is made that is not for a qualified expense, the earnings are subject to taxes plus a 10% penalty tax as well, leaving your grandchild with the tax liability.
But what if you don’t use all of the funds? Not to worry. If the funds go unused, you can transfer the money to another grandchild.
Financial aid is another important aspect to consider when opening a 529 account for your grandchild, so it’s important to understand how it works. The Free Application for Federal Student Aid, better known as FAFSA, views 529 accounts differently depending on whether the parent or grandparent is the account owner.
If a parent is the owner of a 529 account, the account is considered an asset on FAFSA forms. If a grandparent is the owner of a 529 account, the account isn’t considered an asset for FAFSA, but a distribution from the 529 account is considered student income. This is a key difference because assets held by a parent only reduce need-based aid by 5.64% of the assets’ value, whereas student income can reduce aid by 50% of the amount distributed – that’s a big difference! It’s important to remember that when families complete the FAFSA each year, they report income from the two prior years. So, student income received in the last two years of school won’t be reported and will not affect financial aid, which makes the grandparent-owned account advantageous in this scenario.
Along with control and financial aid considerations, there are tax consequences to consider when opening a 529 account for your grandchild as well.
The biggest tax benefit of 529 plans goes to the student. Earnings on any investments in these accounts are free from federal and state taxes as long as they’re used for qualified education expenses. However, your grandchild may not be the only person in this scenario benefitting from tax breaks. In many states, you can deduct contributions from your state income taxes if you’re the account owner. In some states, this applies to any contributor to an account.
Another tax consideration with 529 accounts is that any contribution is considered a gift to the beneficiary. As a gift, it qualifies for the $15,000 annual gift tax exclusion. Additionally, 529 plans allow you to “front-load” your gifts, meaning you can contribute up to $75,000 in one year and treat the contribution as if it were made over a 5 calendar-year period for gift tax purposes. (As a reminder, you are allowed an annual gift tax exclusion of $15,000 per recipient.)
Contributing to a 529 plan for your grandchild can give you an active role in your grandchild’s education and allow you to make a meaningful difference in their life. A college education is one of those gifts that truly keeps on giving – for life.
Interested in starting a 529 plan for your grandchild or learning more? Contact our office. We are always ready to help.
Presented by Elizabeth Schleifer