Many grandparents want to help pay for their grandchildren’s college education.
Opening separate 529 accounts for your grandchildren is a good idea for several reasons.
- You can tailor the selection of the 529 plan and investment options within that plan for each grandchild. For example, let’s assume your grandchildren are located in different states. It could make sense to use the 529 plan in the state where the grandchild lives if there are special state tax breaks for withdrawals from the in-state 529 plan, or if the state provides preferential treatment to residents in its own 529 plan when awarding state grants.
- You can maintain separate 529 accounts for each grandchild to keep your intentions clear. If something were to happen to you and all the funds you set aside to help all your grandchildren are in the name of just one grandchild in a single account, your family could face a difficult time attempting to resolve the ultimate disposition of the 529 funds. With separate accounts, you can easily name the appropriate successor on each account and eliminate any confusion or discord in the event you die or become disabled.
- If the parent of your grandchild has an established 529 plan that accepts third-party contributions, you can contribute to that plan in lieu of opening a new account. Keep in mind, however, the effect that ownership has on a student’s financial aid. Also keep in mind that the IRS has not yet indicated whether a contribution you make to a 529 account owned by someone else will be treated as two gifts, the first from you to the account owner and the second from the account owner to the beneficiary. This is especially important if you want to take advantage of the special gifting rule for 529 plans that allow you to gift up to $80,000 and elect to have it treated as an advancement against your five-year annual gift tax exemption. Consult a tax advisor regarding your plans.
- You can pay gift taxes, use your lifetime exemption, or if you’ve given one person no more than $16,000, use your annual gift tax exclusion. 529 plans offer the added benefit of being able to pre-use up to five years of the annual exclusion amount. This means you can give $80,000 in year one to a 529 plan for a beneficiary using year one’s annual gift tax exclusion of $16,000, and the next four years’ worth of annual gift tax exclusions. If you pass away within this five-year period, however, a portion of these gifts may be includable in your estate for federal income tax purposes.
- The value of assets owned by a grandparent (or other nonparents) is not reportable on the Free Application for Federal Student Aid (FAFSA) financial aid application. This rule extends to 529 plans owned by grandparents. However, if a grandparent provides any type of financial support to the student, that support is reportable on the following year’s FAFSA as student income. The financial aid formula counts student income just as it counts student assets (although the assessment percentages and allowances are different). Most financial aid offices interpret the rules as requiring distributions from grandparent-owned 529 plans to be included as student income, even when the distributions are not reportable for federal income taxes (i.e., they are tax-free). Recent changes under the SECURE Act allowing 529 plans to be used to pay student loan principal or interest may provide a solution.