Data shows that new parents are more motivated than ever before to save for their children’s college. However, there are quite a few barriers keeping new parents from doing so.
Finding the time to sort through all of the savings options is often not feasible for new parents (actually, all parents are usually pretty pressed for time). Figuring out how much to save, what account type to save in, what investments to choose – all of that can take hours of research.
Deciding how to save for college can take hours of research that many parents do not have
Not only is creating a game plan difficult for new parents, but finding the extra money left over each month to save can also be a challenge. Babies often come with a sharp increase in expenses, a new house payment or cost of remodeling, extra health care costs, daycare costs, and so on.
For these reasons, it is not uncommon for grandparents to set up and/or contribute to their grandchildren’s college savings accounts.
Grandparents often have more time, financial resources, and built-up financial knowledge, which makes the college savings decision just a bit easier. Not to mention, they are often just as excited (if not more so) about their new grandchild as the parents are about their newborn!
Grandparents often help parents by setting up college savings funds for their grandchildren
Grandparents often choose 529 accounts for their grandchildren’s college funds due to their tax benefits. However, the question of “whose name should the 529 plan be in?” is an important one. Should grandparents set up and own the future grad’s 529 plan, or should the parents?
Is it better for a parent or grandparent to own a 529 plan?
Here’s what you need to know about owning a 529 account, how it affects the FAFSA and financial aid award, and any tax implications.
What does it mean to be the 529 account owner?
529 plans allow for one, and only one, account owner. The account owner has discretion over how the account is funded and how the funds are withdrawn. Regardless of who else contributes to the 529 account, the account owner chooses how the funds will be used.
An account owner can be anybody in relation to the “beneficiary” (i.e., the future grad) – a parent, grandparent, uncle, friend, or complete stranger. If the future grad is old enough to legally enter into a contractual agreement (i.e., 18 or older), then they can even be the account owner!
529 accounts can have only one account owner, who can be anybody from a parent to a stranger
Can grandparents give to a parent-owned 529 plan?
Yes – grandparents can contribute to a parent-owned 529 plan. And, studies have shown that they are more than happy to do so!
The tax implications of doing so are, as with most things related to college planning, unusually complicated.
Only the account owner can qualify for federal tax-free earnings resulting from contributions to the 529 plan. These tax advantages are recognized when assets in the 529 account are sold for a gain; however, the account owner will not likely notice these benefits on their annual taxes.
Think of these tax advantages as a “lack of a negative” rather than a “positive” when it comes to the account owner’s federal tax return.
Grandparents can contribute, but only the 529 account owner qualifies for federal tax benefits
Some states allow you to deduct a portion of your contributions to a 529 plan on your state tax return. More often than not, this is allowed only for contributions to that state’s 529 plan and only if you are a resident of that state. Not all states have state taxes, though, and not all states with state taxes offer this tax deduction.
Each state has its own rules about whether the grandparent, as a gift-giver, and/or parent, as the account owner, can take a state tax deduction when grandparents contribute to the parent-owned 529 plan. To be conservative, you can assume that nobody will get a tax break for a grandparent’s gift, and you should wait for your favorite CPA to inform you otherwise.
Some states offer state tax deductions for gifts to a 529 account – check with your CPA
Grandparents should be mindful of gift tax implications when contributing to a parent-owned 529 plan. Federal tax law states that total annual gifts from one person to another, such as from a grandparent to a grandchild, which exceed $15,000 for single filers or $30,000 for joint filers, will reduce the gift giver’s lifetime gift/estate tax exclusion of $11.7 million.
Annual gifts exceeding $15,000 can lower the gift-giver’s lifetime estate/gift tax exclusion
Here’s an example to clarify that statement. If a grandparent contributes $20,000 in one year, and files singly, then that grandparent will reduce their lifetime gift/estate tax exclusion by $5,000 ($20,000 – $15,000), down to $11.695 million.
Actually, that’s not always true with 529 plans…sorry to add more complexity to this topic.
When funding 529 plans, federal tax law allows gift-givers to “superfund” a 529 plan by contributing five years’ worth of contributions ($75,000 total for single filers and $150,000 for joint filers) at once with no impact on the giver’s lifetime gift/estate tax exclusion. The catch is that the giver cannot give any more gifts to the recipient over the next five years if they fund the full amount allowed at once.
Grandparents can gift up to $150,000 to a 529 plan with no impact on their lifetime gift tax exclusion
Should a grandparent be the 529 account owner?
Grandparents that want to maintain control over their 529 contributions and receive any available state tax deductions may want to set up their own 529 account. This would not prevent a parent from also opening a 529 account for the same beneficiary, as a single beneficiary may have multiple 529 accounts set up in his or her name.
Setting up a 529 account for someone else, such as a grandchild, is no different than setting up a parent-owned 529 account. The difference between a grandparent-owned 529 plan and a parent-owned 529 plan becomes important when filling out the FAFSA and receiving the student’s financial aid offer.
For 529 accounts owned by the parent, the assets saved in the account are counted against the student’s financial aid award at a rate of $5.64 for every $100 in the account. Distributions from the 529 account during the student’s college years are not counted against the student’s income.
Assets in a parent-owned 529 can reduce the student’s financial aid award by $5.64 for every $100 saved
Currently, assets saved in grandparent-owned 529 accounts are not counted against the student’s financial aid award. However, the 529 distributions are counted as student income on the following year’s FAFSA and reduce the student’s financial aid award by $50 for every $100 distributed.
Prior-year distributions from a grandparent-owned 529 currently reduce the student’s aid by $50 for every $100 distributed
If the student’s family has planned for grandparent-owned 529 distributions, then the reduced financial aid award may not be all that bad. For instance, if the grandparent fully funds the student’s college program, then the 50% reduction in financial aid award won’t matter.
If the student gets half of their college costs funded by grandma or grandpa, that will substantially reduce their financial aid award, but getting half of your college paid for is pretty substantial as well.
Upcoming changes to grandparent-owned 529 accounts
Significant changes to the treatment of grandparent-owned 529 accounts will occur due to the passing of the Consolidated Appropriations Act of 2021.
Starting in October 2022, grandparent-owned assets will no longer be included on the FAFSA. This means that a grandparent can save for their grandchild with no negative impact to the grandchild’s financial aid award.
Starting in October 2022, grandparent-owned 529 plans will no longer impact a student’s financial aid
Before this change, it was typically better for parents to be the 529 account owner. However, with the upcoming FAFSA changes, grandparents will be slightly better off being the account owner due to their lower impact on financial aid.
Grandparents vs. Parents: In most cases going forward, the grandparent is better off being the 529 account owner
Can parents change ownership of their 529 plan?
Parents may want to transfer ownership of their 529 accounts to a grandparent to gain more favorable FAFSA treatment.
Although the actual benefit of this change is likely very small, in most cases, parents can do so. Only six states currently do not have provisions for unrestricted transfer of 529 account ownership.
In most states, parents can change ownership of their 529 plans
In states that do not allow for account ownership transfer, there is a not-so-simple hack that parents can employ. Parents can transfer their 529 account to another state’s 529 plan, maintaining their ownership through the transfer, and then transfer ownership of the account in the state that allows for it.
However, in most states where the account owner has previously benefited from state tax deductions from their 529 contributions, transferring the 529 account out of that state will result in the state requiring reimbursement for past state tax deductions.
These transfers are pretty complicated, so you may want to ask your favorite CPA to guide you through your specific situation if you feel like you may have a compelling reason to change ownership.