When a grandchild arrives, grandparents are often eager to help out financially. At the same time, parents facing a whole host of new expenses may find it difficult to prioritize college—which, like retirement, benefits greatly from early action. In such instances, a grandparent-owned 529 college savings plan can be just what the doctor ordered.
Assets in state-sponsored 529s grow tax-deferred, and withdrawals are exempt from federal taxes when used for qualified education expenses.
“Every dollar saved is one your grandchild won’t have to borrow,” says Robert Aruldoss, a senior research analyst at the Schwab Center for Financial Research. “And you may get a tax deduction to boot.” That’s because 34 states and the District of Columbia offer a full or partial tax credit or deduction for in-state contributions to their 529 plans, and seven states offer a full or partial tax deduction to any state’s plan.1
Not only that, but grandparent-owned 529 assets aren’t factored in to the Free Application for Federal Student Aid (FAFSA®), which helps determine eligibility for grants, work-study programs and loans. With parent-owned 529s, on the other hand, 5.64% of assets are counted.2
One potential downside is that once a distribution from a nonparent-owned 529 plan is made, up to 50% of those funds may be counted as income on a student’s future financial aid applications. However, federal financial aid calculations count such distributions only from the “prior-prior year”—that is, two tax years before the funds were distributed. Hence, delaying distributions from nonparent-owned accounts until the final two years of a child’s college career can help sidestep this potential pitfall.
“Some families use parent-owned accounts to help pay for the early years of college and save distributions from grandparent-owned accounts for the final years,” Robert says. “The point is, if you time it right, you can help a grandchild pay for college without affecting financial aid eligibility.”
1For a complete list of deductibility by state, see finaid.org/savings/state529deductions.phtml.
2Assets and income may be excluded from calculations if below certain thresholds. For more details, see studentaid.ed.gov.