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Grandparents, Be Careful with 529 Plans

More and more grandparents are stepping up to help out with their grandchildren’s college tuition. In fact, a recent study found that over 50% of grandparents said they were either planning to save or were already saving for their grandchildren’s college expenses. The same study indicated that 15% of all qualified tuition plans, known as 529 plans, are owned by grandparents.*

In addition to helping your grandchildren pay for college, 529 plans can reduce your taxable estate and may provide a deduction for state tax.

Another benefit of setting up a 529 plan is that it allows you to retain control of the account and how the money is distributed. This is important if you have an emergency and need to use the money. Any earnings in the plan will be taxed and you will likely have to pay a 10% penalty, but a 529 plan is typically the only revocable way to gift money.

However, the 529 plan you set up for your grandchild or grandchildren may negatively impact the amount of financial aid they receive.

If you open the 529 plan with your grandchild as the beneficiary, it may not initially be considered in the Free Application for Federal Student Aid (FAFSA) calculation that determines federal financial aid eligibility. However, once the money in this account is used to pay for college, it becomes part of the grandchild’s assets.

This could be an issue if your grandchild will be relying heavily on financial aid. The FAFSA calculation considers 20% of any assets owned by the student as part of the expected family contribution to college. For a parent-owned 529 plan, only up to 5.64% of the value of plan is considered in the calculation.

Grandparents have three possible solutions:

  1. You could gift contributions to the parent’s 529 plan, if the plan accepts third-party contributions. Keep in mind that several states do not allow for a state tax deduction in this case.
  2. If you have already established a 529 plan, you could transfer ownership to the parents, if your state allows.
  3. You could use the money in your 529 plan to pay for your grandchild’s last year of college, after the last financial aid decision is made. Unfortunately, this strategy will be unsuccessful at schools that require a College Scholarship Service Profile, which asks if a student is named as the beneficiary of any 529 plans outside of their parents.

The idea is to maximize the value of a 529 plan, so it may make sense for the parents and grandparents to have a plan that incorporates all sources of funding for your grandchild’s education. If you have questions on setting up a 529 plan for your grandchildren, Jemma Financial can help.

* Fidelity Investments, “2014 Grandparents and College Savings Study,” June 2014.

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