If you’re a grandparent looking to save the day by helping your grandkids pay for college, take a second look at a tax-advantaged 529 college savings plan before the year is out.
Rule changes to federal financial aid calculations in 2023 mean new investment opportunities are open for family members to help without hurting financial aid.
Funding the huge cost of college can be tricky when it goes beyond the nuclear family. Not all generations have the same level of wealth, and their highs and lows don’t always line up when it counts toward financial aid calculations. You might want to start saving when a child is born, for example, but you have no idea what the extended family’s financial situation will be 17 years later.
Financial planner William Bevins talks to grandparents all the time who say they want to help but don’t know the best way.
“It’s just like anything else when it comes to taxes: We have to make sure we look at all our options,” says Bevins, who is based near Nashville, Tenn.
Ascensus, an administrator of 529 plans, does not officially track the relationship between the account holder and the beneficiary, but its data shows a correlation that points to a small bump for grandparents compared to presumed parents.
Ascensus data also shows that the flow of ownership has not changed since 2011, and that grandparents with financial advisors tend to open more accounts than those who do it themselves.
Parent and Grandparent Account Ownership
College funding takes a village
Existing advice about grandparents opening 529 college savings accounts—or really any investment, custodial, or other account—includes one big caveat: Any money a nonparent or parent gives to a student while he’s eligible for aid it can count as student income and is assessed at a much higher rate than a parent’s asset. Doing it well requires communication.
Let’s say you gave $5,000 to a high school graduate in May 2022. They’re supposed to report it as income on their Free Application for Federal Student Aid (FAFSA) this year, for their sophomore aid package, and the likely result is that the college reduces your award by $2,500. However, if the parent reported $5,000 in savings, the college would only deduct 5.6%, or $280, to be used for tuition.
Some families have avoided this by waiting to use the money from grandparents and other relatives until after the second year, when they have passed the reporting obligations. But there will be no need to strategize from the FAFSA for the 2024-2025 school year (covering fall 2023), when students no longer have to declare outside financial contributions.
So, starting now for next year, “grandparents can use the 529 and start leveraging it for estate planning,” says Robert Farrington, founder of The College Investor.
One caveat remains: This only applies to the FAFSA, and some schools use a secondary financial aid report called the CSS Profile, which may still ask about outside contributions and count them as student income.
Tax benefits for grandparents
The most immediate tax benefit of contributing to a 529 plan is on your current year’s state taxes if you live in one of the more than 30 states and the District of Columbia that offer a direct deduction. An additional incentive to contribute before the end of this year is that since both SPX stocks,
and TMUBMUSD 10Y bonds,
are still down, you will start your account by buying at low prices.
The main long-term benefit is tax-free growth as long as you use the funds for qualified educational expenses (or face a 10% penalty and tax on the growth). The estate planning aspect is for those who can make a significant contribution, up to five times the annual IRS gift limit. For a pair of grandparents, this is $160,000 per grandchild in 2022 ($170,000 in 2023).
Grandparents with young grandchildren will be most interested in the rule change, because you get the most for your tax-free growth when you start early and let it build up over the years. For those who have been through this before with older children, Bevins thinks they will feel free of restrictions.
“It will make some grandparents want to fund more than they have in the past. They will see this gift as fully accessible and fully valued, whereas before they were penalized,” he says.
529s versus other options
While some savers don’t like the look of 529s that block money for educational uses, the accounts are actually quite flexible. If you have grandchildren spread out in age, you can transfer the money from one beneficiary to another at your discretion or use it for private school tuition. You can save now for babies yet to be born and simply name them in the account when they arrive. For grandchildren who have already graduated, you can help them pay off up to $10,000 each in loans, like your own personal student loan forgiveness program. You can even use the money for yourself if you take a qualifying class.
But still, there are other options to save without such parameters. Ascensus says some grandparents have told them they don’t want to take on the work of having a college savings account and would rather just give money. As of 2022, Ascensus has processed more than $250 million in 529s through its Ugift program, with nearly $2.7 billion gifted since the feature launched in 2007.
Grandparents can save directly for a minor in a custodial account, usually at a bank or brokerage, but be aware of the rules that these accounts hand over to the beneficiary upon reaching the age of majority, which in some cases can be 18. UNest is a service that helps families set up these accounts, primarily for parents, but with an easy gift option for family members. The average UNest account balance is $700 and the average gift amount is $80, says Ksenia Yudina, executive director of UNest Advisors. That’s compared to more than $25,000 for 529s, according to the College Savings Plan Network.
“We see a lot of grandparents giving around Christmas, birthdays and Halloween,” says Yudina.
Grandparents can also save in a brokerage account, trading tax advantages for flexibility. But one final consideration is that in most plans, there’s no limit to how long you have to keep money in a 529 account before spending it, so you can wait and at least get a state tax deduction if you’re eligible.
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