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Opening a 529 for a Grandchild? Beware the Fine Print

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.

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Important Disclosures:

The information provided here is for general informational purposes only and should not be considered an individualized recommendation or personalized investment advice. The investment strategies mentioned here may not be suitable for everyone. Each investor needs to review an investment strategy for his or her own particular situation before making any investment decision.

All expressions of opinion are subject to change without notice in reaction to shifting market conditions. Data contained herein from third-party providers is obtained from what are considered reliable sources. However, its accuracy, completeness or reliability cannot be guaranteed.

Investors should consider, before investing, whether the investor’s or designated beneficiary’s home state offers any state tax benefits or other state benefits such as financial aid, scholarship funds, and protection from creditors that are only available in that state’s qualified tuition program.

Examples provided are for illustrative purposes only and not intended to be reflective of results you can expect to achieve.

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