The Pros and Cons of Grandparent-Owned 529 College Planning Vehicles

College costs and tuition have risen considerably in recent years, making saving for college a much more arduous task for parents. Increasingly, grandparents are stepping up to the plate to help allay some of these future expenses for their grandchildren. Recent data shows that over half of grandparents have either saved or plan to start saving to cover college tuition for their grandchildren. In addition, only 10% of grandparents said that if their grandkids asked for help with college costs, they would not be likely to contribute or offer assistance. This presents an excellent opportunity for prudent financial advisors to speak with clients about ways to help grandparents assist their grandchildren’s collegiate goals.
Approximately 15% of all 529 college savings plans are now owned by grandparents saving on behalf of their grandchildren, a trend that showed continual increases year after year. If clients show a desire to assist their grandchildren with college tuition costs, helping them integrate a 529 college savings plan into their comprehensive financial planning efforts can be beneficial to both the client and their grandchildren.
Aside from the satisfaction of helping their grandchildren through college, one of the primary benefits to grandparents contributing to 529 plans is that contributions to 529 college plans are free from federal income taxes until the funds are disbursed for qualified educational spending. Additionally, 34 states, as well as the District of Columbia, offer tax deductions or credits for contributions to 529 college plan.
While tax-free or reduced-tax contributions are a benefit early in the 529 planning, there are several future advantages available regarding grandparent-owned 529 savings plans. One of the biggest future benefits deal with concerns about estate tax, which can be alleviated by moving large sums from the client’s estate without incurring any tax. It is also helpful to note money in 529 plans can be redeemed with just a modest tax bill by the grandparents if the funds will not be utilized.
It is important to note that any contributions made towards one of these college planning vehicles are treated as gifts. These contributions fall under the annual gift-tax exclusion, which allows individuals to contribute up to $14,000 to every grandchild annually without incurring any gift-tax consequences. If a client is married, they can double that amount with their spouse contributing the same amount without any issues from the IRS. This rule can become a very beneficial tool when planning how to manage estate taxes strategically.
However, there are some other variables that clients and their families should be made aware of when discussing grandparent contributions to their grandchildren’s collegiate goals. If a grandparent puts savings towards a 529 college savings plan, they are not reported on the FAFSA form that determines a college student’s eligibility for financial aid from the federal government. This form also determines the amounts that parents must contribute towards their child’s college education. Grandparent-owned 529 college plans are not applicable when calculating parent contributions. For parent-owned 529 college savings plans, as much as 5.6% of the value of the account is counted towards part of their expected family contribution.
Future financial aid packages can be negatively impacted in certain situations where parents are unable to contribute while grandparents’ have 529 plans established. The issue would arise when funds from grandparent-owned accounts are distributed for college expenses. After the student receives the funds they are then considered student-owned. This could possibly reduce the following year’s financial aid award by as much as 20%.
There are many benefits, as well a few potential shortcomings, in grandparent-owned 529 college savings plans. It is important to work through as many potential scenarios as possible when an advisor speaks with grandparents interested in helping their grandchildren save for college. Prudent financial advisors will be able to assist all parties both now, in reducing income tax liabilities, while also maximizing future benefits and helping to make sure that financial aid packages are not negatively impacted by future distributions.