Should A Grandparent Own A 529 College Savings Plan?
As we know, 529 college savings plans are an excellent way for a parent to set money aside to pay for their child's education. Grandparents also want to do what is best for their grandchildren, but we're discouraged because of its potential impact on financial aid. With a new set of changes to the Free Application for Federal Student Aid (FAFSA), starting in 2021, grandparents no longer have to worry about the "financial aid trap" .1
Current and New System
The current system penalizes the child since receiving money from a grandparent-owned 529 plan is reported as income to the child and impacts financial aid. As a result, financial planners have encouraged parents to only open up a 529 plan in their name and have the grandparents contribute directly to their plan. Untaxed student income can offset financial aid by 50%, meaning that a $5,000 distribution from grandparents 529 could reduce financial aid by $2,500.2 With the new rule and simplified FAFSA form, this will eliminate the financial aid trap.
Keep in mind that a select group of 200 private institutions use what is called the CSS profile. This is not likely to change under the new rules, as these private institutions could still impact your child's financial aid.
Overall it is an excellent idea for a grandparent to open up a 529 plan for their grandchild. One of the benefits is that the grandparent can have more control of the money. For example, they can control the money's investments and distribution if their grandchild decides not to attend college or gets the money elsewhere through scholarships. In addition, the grandparent can change the beneficiary or use the money themselves.
The grandparent could get a state income tax break-through savings in a 529 plan. Over 30 states have an income tax break for funding 529 plans. 529 plans can also help with an estate planning legacy, enabling the grandparent to provide something meaningful to the grandchild while they are alive. There also is a benefit of being able to front-load the 529 plan. For example, a couple could contribute $120,000 ($30,000 each year) over the next four years in 2021. In addition, a married couple could contribute $15,000 per year to avoid filing a gift tax receipt in 2021.
One of the drawbacks of a 529 plan is that earnings for non-college-related expenses are taxed at the ordinary income of the owner of the plan plus a 10% penalty. On the other hand, contributions to the plan come out tax-free. But you can change the beneficiary of the plan or even use the money to pay for higher education yourself. So why not take that cooking class you always dreamed of?
Another drawback is that you are more involved, i.e., funding your grandchild's college education. Some grandparents don't want to take on this responsibility and prefer their son or daughter to take on this role. In this case, it might be better to contribute to a parent-owned 529 plan up to $15,000 per year or $30,000 if a married couple in 2021.
Given the new rules and the desire of grandparents to contribute towards their grandchild's college education, this FAFSA change will, I'm sure, provide more impetus for more grandparent-owned 529 plans. Reach out to me on the contact page below to schedule an initial conversation about how a 529 plan fits into your financial goals.
*This content is developed from sources believed to be providing accurate information. The information provided is not written or intended as tax or legal advice and may not be relied on to avoid any Federal tax penalties. Individuals are encouraged to seek advice from their own tax or legal counsel. Individuals involved in the estate planning process should work with an estate planning team, including their own personal legal or tax counsel. Neither the information presented nor any opinion expressed constitutes a representation of a specific investment or the purchase or sale of any securities. Asset allocation and diversification do not ensure a profit or protect against loss in declining markets.