If you’re a grandparent looking to save the day by helping your grandchildren pay for college, take a second look at a tax-advantaged 529 college savings plan.
Rule changes to federal financial aid calculations in 2023 mean that new investing opportunities are open for family members to help out without hurting financial aid.
Financing the enormous cost of college can be tricky when you go beyond the nuclear family. Not all generations have the same level of wealth, and their ups and downs don’t always align when it counts for financial aid calculations. You might want to start saving when a child is first born, for instance, 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 like anything else that deals with 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, doesn’t officially track the relationship between account holder and beneficiary, but its data does show a correlation that points to a small grandparent bump compared with presumed parents.
Ascensus’ data also show that the flow of ownership hasn’t shifted since 2011, and that grandparents with financial advisers tend to open more accounts than those who do it themselves.
Parent vs. grandparent account ownership
College financing takes a village
Existing advice about grandparents opening 529 college savings accounts — or really any investment account, custodial or otherwise — comes with a huge caveat: Any money from a non-parent given to a student while eligible for aid can count as student income and is assessed at a much higher rate than a parental asset. Getting it right requires communication.
Say you gave $5,000 to a high school grad as a present in May 2022. They are supposed to report it as income on the Free Application for Federal Student Aid (FAFSA) this year — for their sophomore aid package — and the likely result is that the college lowers its award by $2,500. If the parent reported savings of $5,000, however, the college would subtract only 5.6%, or $280, to be used for tuition.
Some families have avoided this by waiting to use money from grandparents and other relatives until after sophomore year, when they’re past reporting obligations. But strategizing won’t be necessary starting with the FAFSA for the 2024-2025 academic year (filled out in fall 2023), when students no longer have to report outside financial contributions.
So starting now, “grandparents can use 529s and start leveraging that for estate planning,” says Robert Farrington, founder of The College Investor.
One caveat remains: This applies only to the FAFSA, and some schools use a secondary financial aid report called the CSS Profile, which may still ask about outside contributions and consider them as student income.
Tax benefits for grandparents
The most immediate tax benefit of contributing to a 529 plan is on your current-year state taxes if you live in one of the 30-plus states and District of Columbia that offers a direct deduction. An additional incentive for contributing before the end of this year is that since both stocks
are still down, you’ll start off 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 comes in for those able to make a major contribution — up to five years times the IRS annual gift limit. For a pair of grandparents, that adds up to $160,000 per grandchild for 2022 ($170,000 in 2023).
Grandparents with young grandchildren will be the most interested in the rule change, because you get the most bang for your tax-free growth when you start early and let it accrue over years. For those who have been through this before with older kids, Bevins thinks they’ll feel free of restrictions.
“It’ll make some grandparents want to fund more greatly than they have in the past. They’ll view this gift as being fully accessible and fully valued, whereas before they were penalized,” he says.
529s vs. other options
While some savers don’t like the aspect of 529s that locks in the money for educational uses, the accounts are actually quite flexible. If you have grandchildren spread out in age, you can shift 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 just name them on 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 class that qualifies.
Starting in 2024, you’ll be able to rollover up to $35,000 in unused savings, under certain conditions outlined in the omnibus spending bill, including that the account must have been active for at least 15 years.
But, still, there are other options to save without such parameters. Ascensus says some grandparents have told them that they don’t want to take on the work of owning a college savings account, and would rather just give money. So far in 2022, Ascensus has processed over $250 million into 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 firm, but be aware of the rules that these accounts turn over to the beneficiary at the age of majority, which can be 18 in some cases. UNest is one service that helps families set up these accounts, mostly for parents, but with an easy gifting option for relatives. The average balance for UNest accounts is $700, and the average gift amount is $80, says Ksenia Yudina, chief executive officer of UNest Advisors. That’s compared with over $25,000 for 529s, according to the College Savings Plans Network.
“We do see a lot of grandparents giving around Christmas and birthdays and Halloween,” says Yudina.
Grandparents can also just save in a brokerage account, trading tax advantage for flexibility. But one last consideration is that in most plans, there’s no limit on how long you have to keep the 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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