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When Grandparents Help Pay for College: 529 Plans

webinargradBy most estimates, college costs are increasing at roughly two times the inflation rate annually. It’s a startling statistic that leaves many parents and students scratching their heads as to how to pay for an education. Fortunately for some families, grandparents are able to step in and cover part of the costs, even getting some tax advantages in the process. One of the simplest and smartest ways for grandparents to help is through a 529 college savings plan.

The basics

A 529 plan is essentially a savings account intended solely for the purpose of covering qualified education expenses. As a grandparent, you can establish a 529 plan yourself and name your grandchild as the beneficiary, or you can contribute to an existing plan, such as one owned by the parents.

Tax implications

Contributions to 529 plans are not deductible on your federal tax return, but the investment grows tax-deferred. When the funds are later withdrawn to pay for college, they come out tax-free as long as they’re used at an accredited college in the United States or abroad. Otherwise, the money is taxed upon withdrawal.

Who owns it?

Grandparent-owned 529 plans are not counted as a parent or student asset, but any withdrawals are counted as student income and therefore can affect a student’s financial aid eligibility. In contrast, parent-owned and student-owned 529 plans count as assets, and the withdrawals are not counted as student income.

If your grandchild is still a ways off from entering college, you can establish a 529 in your own name and take advantage of the estate-planning benefits. That is, you can transfer assets out of your estate without giving up control and reduce your income tax while enjoying tax-free earnings on contributions.

Consider the following scenario.

Say your grandson Joey is 10 years old and you establish a 529 that you control and in which you name Joey as the beneficiary. Federal law permits a lump-sum gift of up to $65,000 ($130,000 for joint gifts). Meanwhile, you avoid the federal gift tax by electing to treat the gift as if it were made in equal installments over a five-year period.

As account owner, you retain control of the funds. That fact comes in handy if you have unexpected medical expenses and need to withdraw the money (agreeing to pay the 10 percent penalty on the earnings, plus income tax).

Here’s where things gets tricky — or where you get creative.

To avoid affecting your grandkid’s aid eligibility, you can transfer ownership of the 529 account to a parent of the beneficiary before the first aid application is due. So, say you transfer ownership to Joey’s father, then it becomes a parental asset and withdrawals are not considered student income.

You’ll need to check on your state’s rules regarding transferring ownership, as some states only allow it if there’s a court order or the owner dies. One possible workaround is to roll over the assets tax-free to a state with generous transfer rules.

The bottom line

A little goes a long way when you contribute to a 529 plan. Even $50 per month contributed from a child’s birth can add up to $21,000 by age 18, assuming 7 percent interest per year.



These plans offer unique tax advantages that are well worth consideration when college is still several years down the road. If your grandkids are ready to head off to college, consider gifting cash to your grandchild. With the annual exclusion, you can give up to $14,000 in cash or other assets tax-free.

Next steps

Start by checking out your state’s 529 plan offerings. FinAid.org offers a handy list of state plans, including prepaid tuition and college savings plans, fund expenses, ratings, minimum contributions and more. Do your research, and work with your financial planner to settle on the best arrangement for your situation — and your grandchild’s.

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