Paying it Forward

Many grandparents want to help their grandkids pay for college. If this is one of your goals, the best way to achieve it is by opening a 529 plan in your name with your grandchild as the beneficiary. 529 plans offer unique benefits for grandparents, including flexibility to not impact the grandchild’s financial aid awards, being able to retain control of the assets throughout the life of the account, and ease of management.

One of the most common mistakes grandparents make is they give their kids cash and say, “This is for the grandkid’s 529 plan. Please deposit into their account.” A lot of parents have set up a 529 plan for their young children, so it might make sense to keep all the college savings consolidated into one account when you don’t know all the rules. Actually though, this hurts the child’s ability to qualify for financial aid after they get accepted into college.

A parent-owned 529 plan counts against a child’s financial aid awards at a rate of 5.64% per year. Assume a parent-owned 529 plan has a $30,000 balance. 5.64% of $30,000 is $1,692. A student qualifying for $8,000 of financial aid will have it reduced to $6,308 for that college year.

A grandparent-owned 529 plan does not count against a grandchild’s financial aid awards. If grandparents have saved up $20,000 (or even $100,000) in a 529 plan for their grandchild, this doesn’t reduce the grandchild’s financial aid award by even one penny!

There is a dark side to this though. Whenever money from the grandparent-owned 529 plan is used, it counts as “student income” for the grandchild. Financial aid calculations assume 50% of any student income will be for education costs and reduce their financial aid by this amount. So, for example, if grandparents use $5,000 from their 529 plan to help pay for college, their grandkid will lose $2,500 of financial aid.

Luckily, smart financial advisors have come up with a strategy for this. Financial aid calculations use income from two years prior when applying for financial aid. Grandparents should wait until their grandchild is a junior or senior in college before using any of their 529 plan money. This way, the withdrawals never reduce their grandchild’s financial aid awards.

Another helpful aspect of a 529 plan is that it doesn’t just need to be used for a four-year university. This money can be put towards any post-secondary education, including trade schools, community colleges, and grad schools. And if one grandchild doesn’t use all of the 529 plan (or any of it), it can still be used for another relative. You can do this by simply changing the beneficiary on the account. So, by opening a 529 plan in your name, you actually have the potential to help more than just one grandchild.

 

How To Open And Fund A 529 Plan

529 plan contributions are not deductible at the Federal level, but over 30 states offer a tax deduction or credit for contributions. If your state offers this, then look first to open a 529 plan in your state. It doesn’t matter where your grandchild lives or where they will go to college.

If you live in a state that doesn’t offer a tax deduction or credit, then you can open a 529 plan in any state. A great place to begin your search is at www.savingforcollege.com. This website can guide you through the process of selecting the right plan for you. It compares costs, investment options, and service levels.

Once you have chosen your 529 plan and have it opened, fund it with after-tax money. Don’t withdraw money from an IRA or 401(k) to fund a 529 plan unless you are in the 12% tax bracket. You will owe taxes on the IRA withdrawal so it would cost more to help pay for your grandchild’s college.

In 2019, each grandparent can deposit $15,000 into each grandchild’s 529 plan. This limit can increase each year, so keep an eye on these limits. Grandparents can pre-fund up to 5 years’ worth of funding into a 529 plan. So, if the plan was opened in 2019, they could fund $75,000 per person, or $150,000 per couple.

One thing to be aware of is the taxes and penalties that can be applied to portions of a 529 plan. While the contribution portion of a 529 plan can’t be taxed so long as it was funded with after-tax money, the earnings portion of a 529 plan can be subject to income tax and a 10% withdrawal penalty if used as a non-qualified distribution. A non-qualified distribution is any portion of a withdrawal from a 529 plan used for anything other than qualified education expenses. Examples of qualified education expenses include tuition, books, and room and board (in some instances).

This may make you nervous, but there’s no need to worry! As long as your 529 plan is used for the purpose of your grandkid’s education, you will be just fine. And remember, if one grandkid doesn’t use it all, the leftover funds can still be applied to another relative.

So, enjoy those grandkids! And help them with college by opening a 529 plan in your name. It helps you keep control of the account and doesn’t impact your grandchild’s financial aid in the future.

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