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COLLEGE SAVINGS 101

529 in grandparent's name can be risky

12/22/2008

QUESTION:
Dear Joe,

I am the parent of two young children and plan to establish a 529 plan to offset future college expenses. Is it more advantageous to establish a 529 plan in the name of a grandparent from a financial aid perspective?

-- Alan

ANSWER:
Dear Alan,

It all depends.

Grandparent assets, including grandparent-owned 529 plans, are not reportable on the Free Application for Federal Student Aid, or FAFSA. If you or your child were to own the 529 account, as much as 5.64 percent of its value would be included in the "expected family contribution," or EFC. Clearly, there is an advantage to a grandparent 529 account when it comes to asset value.

However, there may be a disadvantage when it comes to income. Distributions from a grandparent-owned 529 during a base year (the calendar year prior to the application year) may have to be reported on the FAFSA as student income, thereby decreasing aid eligibility. (The school's interpretation of federal law will determine if reporting is required.)

Distributions from a parent- or student-owned 529 account are not reported as financial aid income as long they are tax-free for federal tax purposes.

Even if turning the 529 account over to a grandparent would improve your children's eligibility for financial aid, I don't think it's a good idea to let someone else own an account that was funded with your money.

Remember, grandparents who are account owners have legal control over the money. Account owners have the right to decide when and for what purpose a distribution is made. They can change the beneficiary to a different family member, and they can even request a refund for their own use (subject to tax and a 10 percent penalty on earnings).

Naturally, you expect the grandparent to act in your children's best interests. But consider the possibility that the grandparent is sued or that the grandparent becomes sick or disabled for a lengthy period and must apply for Medicaid benefits. The 529 account may go to satisfy a judgment or pay medical expenses. Things might also get a little dicey if the grandparent dies and the surviving grandparent remarries.

You may decide these possibilities are too remote to worry about. But they exist, nevertheless. And at this point, when your children are still young, you should not even be counting on financial aid. Who knows what the financial aid system, or your family finances, will look like by the time your children are ready to apply?

My advice: Keep the account in your own name.

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