Can Grandparents Use A 529 Savings Plan To Cut College Costs?
For teenagers, there are countless benefits to having loving, involved grandparents in their lives. And let’s face it, that sometimes includes the pricey gadgets and other goodies that grandparents buy for their grandchildren.
Yet for today’s teenagers, who are facing the steepest college costs of any previous generation, perhaps the best gift of all is to help a grandchild pay for college.
One way to do this: contributing to a 529 college savings account for a grandchild.
But what is a 529? Not surprisingly, many grandparents have never heard of a 529 savings plan. “When they were putting their own children through college, these plans didn’t exist,” notes Michael Graci, director of investment education for Blackrock.
Think of a 529 as an IRA or 401K for college. Like retirement accounts, money contributed to this education savings plan grows tax free. And withdrawals are also tax free, so long as the money is used for qualified education expenses. This includes tuition, room and board, books and other supplies. Even small amounts can help during the college years. Books alone can cost a student several thousand dollars a year.
Some Other Advantages of the 529 Savings Plan
- Money saved can be used at any college the country.
- The money can be used for undergraduate or graduate education.
- Money saved for one student can be transferred to another (for example, if one student gets a scholarship and no longer needs the funds).
A grandparent can set up a 529 savings plan in their own name, with a grandchild named as a beneficiary. Or they could contribute directly to an existing 529 plan (say one set up by a grandchild’s parents). Of course, there are benefits and drawbacks to each approach. Grandparents should take time to determine what’s best for their personal financial situation.
The pluses of grandparents setting up their own 529 plans include:
- Tax breaks: In addition to the federal tax savings—as noted, the money withdrawn is not subject to tax when used for a qualified expense—a majority of states offer tax breaks on contributions to their state’s 529 plans.
- Control: The owner of a 529 account retains full control of the money invested in the account. That means, if a grandparent needs that money—say for a health emergency—he or she can still access it. (Though there can be penalties when withdrawing income earned by the account.)
- Set it and forget it: Many plans require only minimal monthly contributions—even as low as $25—to get started.
However, there is also the chance that withdrawals from a grandparent’s education savings plan can impact a grandchild’s financial aid award, explains Graci, who’s written about the plans in Blackrock’s A Grandparents Guide to the 529 College Savings Plan. If a grandchild is not eligible for financial aid (because the family income is too high), this isn’t a concern.
Using An Education Savings Plan Properly
But for grandchildren receiving financial aid, the funds used from a grandparent’s 529 college savings account must be reported as untaxed income on the FAFSA form for the year following that in which the funds are used. In other words, if funds are used for freshman year, they must be reported on the FAFSA for sophomore year (and so on). “That can reduce the financial aid package by up to 50 percent of that amount,” cautions Graci.
One way around this: wait to use the funds in a grandparent’s 529 until the final year of college. “A student can wait until the final year of college to take the distribution from the grandparent’s account,” says Graci. “Once you‘ve filed the last financial aid form, there will be no financial aid form to fill out next year.”
In fact, in this scenario, the funds can be used as early as spring semester junior year, since the final FAFSA can be filled out in January of junior year.
Other ways to avoid impacting financial aid can include transferring ownership of the 529 savings plan before the grandchild’s senior year of high school. In general, grandparents will want to carefully check the terms and conditions of any 529 plan to find out what their options are before investing.