Grandparents and 529 College Savings Plans: What You Need to Know
By Joe Messinger, CFP®
November 3, 2023
Updated November 2023.
Grandparents want to help. They see the expense ahead for their kids to pay for college education for their grandkids. The goal for everyone is to help the student get an excellent education, graduate with little or no debt, and live a fulfilling life. Many grandparents choose to open a 529 college savings plan to help pay for college, and they must be aware of a few things before jumping in feet first.
What is a 529 Plan?
A 529 plan can be an appealing option to help save and is, by and large, the best tool to do so.
A 529 plan is a tax-advantaged savings plan designed to encourage saving for future education costs. It’s named after Section 529 of the Internal Revenue Code. These plans are usually sponsored by states, state agencies, or educational institutions and are authorized by the IRS.
There are two main types of 529 plans: prepaid tuition plans and education savings plans. The prepaid tuition plans allow you to pay for future tuition at today’s rates. The Private College 529 is one such prepaid tuition plan with nearly 300 member colleges. Education savings plans operate more like investment accounts, allowing you to contribute money that can grow over time.
One of the main advantages of 529 plans is the potential for tax-free withdrawals when the funds are used for qualified education expenses, such as tuition, books, and room and board. However, it’s essential to check the specific details of each plan, as they can vary by state.
How Do You Fund a 529 Plan?
Grandparents may use their $17,000 gift maximum (per year) to contribute money to a 529 Plan for their grandchildren without tax penalty. Grandparents can also choose to make a one-time deposit of up to $85,000 from each grandparent, per child, total, without running into gift tax penalties. In this case, the $17,000 gift maximum (2023) per year is considered to be spread out over five years. Moving money this way is a great estate planning tool for grandpa and grandma, and can help to boost your grandchild’s college savings quickly.
All grandparents can take advantage of the tax benefits of 529 plans, like tax-free withdrawals when used for qualified education expenses, tax-deferred growth of the investment, and possible state tax deductions for the grandparents.
Will a Grandparent-Owned 529 Plan Impact a Student’s Financial Aid?
In a word – no. Most colleges use the Free Application for Federal Student Aid or FAFSA to calculate financial need or the expected family contribution based on the income and assets of the parents and the student, so that is what we will focus on in this article.
If the 529 is owned by the custodial parent or the dependent student, the plan is reported as an asset of the parent on the FAFSA. When owned by an independent student, the assets are reported as the student’s assets. When the 529 is owned by the grandparents (or anyone else for that matter), FAFSA does not view the 529 as an asset that counts toward federal aid calculations.
However, historically, distributions from a grandparent-owned 529 Plan were considered untaxed income for the student or beneficiary and would have been assessed at a higher percentage in FAFSA calculations. Now, however, as a result of the FAFSA Simplification Act distributions paid to the school or the beneficiary/student directly don’t count as untaxed income for the student and don’t impact their income calculations for the FAFSA.
In short, the updated rules of the FAFSA will make it notably easier for grandparents to help their grandkids with college costs without negatively impacting their financial aid eligibility so dramatically. New updates mean that students don’t have to report cash support, so grandparent-owned 529 plans won’t impact their eligibility for financial aid, and neither will cash payments toward their tuition directly.
Because of the way these new rules are set up, grandparents may be able to start taking advantage of this opportunity now. Make sure to reach out to a fee-only financial planner with college planning expertise to ensure you’re playing by the rules if you choose to go this route.
What else can grandparents do?
As a result of these new rules, a parent may want to explore transferring ownership of an existing 529 plan to a grandparent. Parents can continue to make contributions directly to the grandparent-owned 529 plan, but the asset will not be reported on the student’s FAFSA.
For example, if a parent had a 529 plan with a $100,000 balance, it would be assessed at 5.64% and add $5,640 to the student’s Student Aid Index. So, transferring ownership of the 529 to the grandparent would reduce the SAI by $5,640.
You will want to consult with the 529 plan to determine if they allow for the ownership to be transferred and speak to a qualified tax professional to ensure there are no gift tax consequences.
Example One: You have $100,000 in a 529 plan, and a $50,000 Student Aid Index.
Case Study One: Parent maintains ownership of a $100,000 529 plan.
$80,000 COA – $50,000 (SAI) = $30,000 Financial Aid eligibility.
Case Study Two: Transfer ownership of $100,000 529 from the parent to a grandparent to increase aid eligibility.
$80,000 COA – $44,360 (SAI) = $35,640 Financial Aid Eligibility
Before even bothering to go through the process to transfer the 529, you will need to answer these three critical questions:
- What is my Student Aid Index?
- Am I a financial aid candidate at a particular school?
- Will this strategy actually help me qualify for additional need-based aid?
Example Two: You have $100,000 in a 529 plan, and a $100,000 Student Aid Index.
Case Study One: Parent maintains ownership of a $100,000 529 plan.
$80,000 COA – $100,000 (SAI) = $0 Financial Aid eligibility.
Case Study Two: Transfer ownership of $100,000 529 to a grandparent to increase aid eligibility
$80,000 COA – $94,360 (SAI) = $0 Financial Aid Eligibility
The strategy will reduce your Student Aid Index, but you still do not qualify for any aid – so, in this case, the juice ain’t worth the squeeze!
Check out our FREE COLLEGE MONEY REPORT to learn your Student Aid Index and financial aid eligibility at three schools side by side!
What non-529 options are available?
Grandparents could wait until after a student graduates from college to gift them the money. Most students today will leave college with student loans. Assistance paying off these loans could be an excellent solution for grandparents wanting to help, but who either were late to the college funding party or didn’t have the cash flow to support 529 Plan funding while their grandchildren were in school. Remember that the annual gift tax annual exclusion maximum is $17,000 a year (2023).
If you’re unsure of how you can best support your grandkids, talk to their parents! Grandparents need to understand the family’s situation in terms of financial aid, and what type of funding would be helpful to bridge any cost gaps after the student’s aid is calculated.
The conversation should explore all the options available and determine which is the best fit for everyone to maximize financial aid and minimize taxes. Oftentimes, working with a financial planner to help facilitate these conversations can be helpful, and provide all family members with a big picture view of their college-bound student’s financial strategy. Want to learn more? Reach out to us today! We’d love to speak with you.
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