What Grandparents Should Know About 529 Plans

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They say it takes a village to raise a child, and when it comes to helping with the rising costs of college, grandparents around the US are stepping up. In fact, more than half of grandparents are contributing or planning to help their grandchildren with their post-secondary educational expenses.

According to the College Board, the average cost of tuition and fees for a private college in 2019-2020 is $36,880. Times that by four years and multiple children, and many college-bound kids and their parents are looking at crushing debt. Even public institutions have an average annual price tag of $10,440 for instate students, and that’s not including things like travel to campus, books and spending money. Considering nearly 60 percent of undergraduate students these days take six years to complete a four year degree, the costs are staggering.

Here’s another alarming statistic. In 1989, the cost of a 4 year degree averaged $52,892 (adjusted for inflation). Flash forward to 2016, the cost of the same degree was nearly $104,480 (adjusted for inflation), essentially doubling, while salaries have certainly not gone up commensurately these past two decades.

All this is to say that the cost of the college dream is out of reach for many young scholars without taking on crippling loans, earning coveted scholarships or winning the lottery. That’s why many prudent and forward thinking grandparents are investing in funds earmarked to help their grandchildren reach their educational potential. While the youngsters might prefer to get toys, trips or smartphones as presents over the years, every deposit towards their future education is a more prudent gift.

One such investment vehicle is a 529 plan, a state-sponsored tax-advantaged investment account specifically for educational expenses. Many parents are familiar with these plans, but grandparents who want to leave a legacy for their beloved grandchildren might want to open one themselves. It’s almost like setting up an inheritance but with a specific educational purpose. After-tax contributions to this plan are tax-free as long as they are put towards expenses like tuition, mandatory fees, textbooks, room and board, computers and so forth. Each school has a list of eligible expenses this money can be used towards.

As of 2017, 529 contributions can be used for elementary, middle and high school expenses too, and as of 2020, up to $10,000 from the plan can be used towards student loans. Furthermore, the 529 plan rules for grandparents differ slightly from parents, especially in terms of how it impacts federal financial aid. You should speak to a financial advisor to make sure you understand all the details.

Having your own plan as a grandparent rather than just contributing to a parent’s 529 plan has some advantages beyond just helping your grandchild with their colleges expenses.

A 529 plan can help you with your estate planning goals too. Putting money into a plan removes the balance from your taxable estate, so you’ll lower your estate tax liability upon your passing. On the other hand, money in the 529 plan is considered a gift to your grandchild beneficiary, which means they could have to pay a federal gift tax on it if the amount exceeds the annual gift tax exclusion ($15,000 per individual donor and $30,000 per couple). The best way around this tax is to contribute an allowed lump sum of five years’ worth upfront as long as it’s below the five-year exclusion limit. In this way, grandparent-owned 529 plans are an appealing option for a tax-free wealth transfer (although estate tax would have to be paid if you were to die within that five year time period.)

Your money will grow in the 529 account tax-free, and some states even offer a tax break for contributions made to a plan.

Having your own 529 plan for your grandchild gives grandparents another stash of money that, should you need it, can be tapped in an emergency. At any time before the money is withdrawn you can take the money out, if necessary. You would have to pay a penalty of 10 percent plus taxes on any investment gains, but the nest egg is always yours should you need it. Hopefully you won’t ever have to withdraw from it, but it’s like a Plan B should life throw you an unexpected curve ball.

Note, having a 529 plan for your grandchild could be a strike against you if you think you might need Medicaid for future nursing home expenses. In some states, money in a 529 plan counts as a Medicaid asset which may impede your eligibility for assistance. You would have to wait until the money is withdrawn by your grandchild before qualifying for Medicaid in that situation.

Here’s another caveat on 529 plans. The distributions from a grandparent owned 529 plan are considered untaxed income to the student beneficiary. That income could impact the amount of financial aid your grandchild is eligible for as much as 50 percent of the distribution amount in the following year. You should encourage your grandchild to withdraw in their junior and senior years to avoid the two-year look-back.

You may be concerned that if you set up a 529 plan for your grandchild and then they choose not to go to college, that money will be wasted. Rest assured, you as the account holder can name a new beneficiary as long as it is a relative of the original beneficiary.

Are you planning on helping your grandkids with college?

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