529 plans have become the most popular form of savings for college because of the many benefits they offer including tax-free investment earnings.
Across the country, it is the joy of grandparents to spoil their grandkids in just about every conceivable way, often in the form of a piece of candy, a bit of money, or a homecooked meal. As the price of college has continued to rise in recent years, many grandparents have started to consider whether they can contribute to their grandkids’ future by limiting education costs and reducing student debt. One of the most effective tools for doing so, in many cases, is the popular 529 plan, which offers tax breaks, investment earnings, and other financial benefits that made college more affordable for families; that said, should a grandparent own a 529 plan? To find out, keep reading as the experts at Sootchy explain.
With so many different types of college savings plans out there, it’s tough for any one option to stand out, but 529 plans are widely recognized as perhaps the top option for parents, grandparents, and anyone else looking to help cover the outstanding costs of college. The reason for this is simple: No other kind of plan offers the combination of tax benefits and earning potential that you get from a 529 plan, whether it’s owned by a grandparent or not.
One of the hallmarks of a 529 plan is the option to invest funds in one of several ways. Options vary depending on what plan you choose and which state is administering it, but in general, you can pick either a static investment portfolio – one in which each investment is chosen manually and remains the same until the account owner makes a change – or an age-based portfolio in which investments shift from somewhat risky to more conservative as the beneficiary of the account gets closer to the start of their college career.
In either case, plans often offer a number of selections for college savings plans and ABLE accounts, while the funds in a prepaid tuition plan are invested by the plan administrator, not the account owner. In any case, a 529 plan owned by a grandparent can generate substantial gains over the course of a grandchild’s early years.
Although many investment accounts allow for the buildup of funds in the same way as a 529 plan, none of the others eliminate federal (and often state) taxes from the equation. When your 529 plan earns money through investments, any gains are tax-free, as long as they go toward a qualified education expense. Grandparents can also add as much as $15,000 a year to a 529 plan without having to worry about the federal gift tax, and many states even offer deductions or credits for those who contribute to such a plan (up to a limit, which varies by state).
Another key tax benefit of 529 plans – and one that’s especially appealing to many grandparents – relates to the federal estate tax. When a grandparent owns a 529 plan, the funds in that account are no longer considered part of their estate five years after they’re deposited; however, as the account owner, that grandparent still retains control over the funds and can withdraw them – after income tax and a 10% penalty – at any time, for any reason.
While there’s no doubt that a 529 plan can be a great tool for grandparents looking to help their family cover the cost of education, one particular point of concern will likely affect how the funds in the account are used: financial aid. Even with a wealth of savings options at their disposal, many families need the boost provided by financial aid to be able to pay for college, and a 529 plan owned by a grandparent could have a significant impact on how much a student receives.
The reason comes down to what’s called the “expected family contribution” (EFC), which is the government’s measure of how much a family could be expected to put toward higher education; the higher the EFC, the less a student get in federal aid. For 529 plans owned by parents, only a small portion of the funds – 5.64% – contribute to the EFC, whereas money spent from a grandparent’s 529 plan will add 50% of its value to the EFC calculation. In other words, if you give your grandchild $10,000 out of a 529 plan, it will reduce their financial aid by 50% of that amount, or $5,000.
There are, however, some ways around this problem. One option is to simply change the owner of the account to one of the student’s parents, though not all plans allow this. Similarly, grandparents who own a 529 plan can transfer one year’s earnings and contribution to a plan owned by the student’s parent.
The best option may be to simply wait to distribute the funds. Payments made from a grandparent’s 529 plan will only affect financial aid if made before January 1 of their grandchild’s sophomore year – provided that grandchild graduates in four years. Alternatively, you could wait until after your grandchild has graduated and use the funds to pay down their debt, since student loans are considered eligible expenses (up to a certain amount).
Though it’s up to each grandparent to decide whether they should own a 529 plan, the benefits of this college savings option are certainly worth considering. If you’d like to open a 529 plan for your grandchild, know that the professionals at Sootchy can help you open and manage an account with ease. Learn more by visiting us online today.