Before you open a grandparent 529 account…
According to Fidelity’s 2014 Grandparents and College Savings Study, 53 percent of grandparents said they are currently saving or planning to start saving to help pay for a grandchild’s college education. As last week’s slideshow illustrated, one effective way for grandparents to build a college fund is with a 529 plan. However, despite all of their benefits, there are a few questions you should ask yourself before opening a grandparent-owned 529 account:
1. Should You Work With a Financial Advisor?
You can open a 529 account directly on the plan’s website, or you may choose to work with a financial professional to purchase a plan. If you are comfortable selecting your own plan and monitoring your investments, you may be able to save money by opening a direct-sold plan. With an advisor-sold plan, you’ll likely pay upfront commission anywhere between 1-5.75% of the amount invested.
That being said, savings in a 529 plans are often used as an estate planning tool for grandparents. If this is the case, you may want to include your financial advisor when selecting a plan.
2. Are You Currently Using Other Approaches to Reduce Estate Taxes?
If you’re using an estate plan that already applies your annual gift-tax exclusions to life insurance trusts, family limited partnerships or other vehicles, you may not have enough left to apply toward 529 contributions. That means the amount you put into your grandchild’s college fund will be considered a taxable gift and it will also count against your lifetime exemption.
If this is the case, you can instead choose to save the money another way and wait to pay the tuition bill directly when your grandchild gets to college. Direct tuition payments are not considered a gift under the Section 2503(e) exclusion. Keep in mind that this only applies to tuition and does not include other qualified expenses (e.g. books, equipment, room and board, etc.)
3. Will Your Grandchild Apply for Financial Aid?
The assets held in a grandparent’s 529 account have no affect on a student’s financial aid eligibility, but when the grandparent withdraws the funds to pay for college it is reportable on the following year’s FAFSA as student income. This will drive up the student’s Expected Family Contribution (EFC), and higher EFC means less financial need.
One way to get around this issue is to wait to withdraw the funds until after January 1 of your grandchild’s sophomore year of college. If the student will graduate in five years, wait until after January 1st of the junior year to take the distribution.
4. Can You Afford to Help?
According to Fidelity’s survey, 49% of grandparents feel that they have a responsibility to help with college expenses if they are able to. However, the truth is that many senior citizens don’t have the available assets to help. As a recent article from CNBC points out, the number of Americans age 60 and over who carry student loan debt has almost tripled since 2005 according to the Federal Reserve Bank of New York’s August “Household Debt and Credit Report”. Part of this increase is likely due to grandparents borrowing to help pay for their grandchildren’s college expenses. If a retired person fails to repay their loans, the government may withhold part of their social security check, which may be their only source of income.
Savings in a 529 plan can also affect Medicaid eligibility. The assets held in a grandparent’s 529 account are considered available assets that must be spent on medical and long-term care expenses before Medicaid payments begin.
5. Have You Discussed Your Plans With the Parents?
Your grandchild’s parents may also be saving with a 529 plan, so it’s a good idea to have a discussion about withdrawals before the first tuition bill arrives. You’ll want to know how much the parents are withdrawing and what they are spending it on before you take a distribution. 529 funds can be spent tax-free on any qualified education expense, such as tuition, fees, books, supplies and equipment required for course enrollment and some room and board. Any non-qualified purchases will be subject to income tax as well as an additional 10% penalty tax. To keep things simple, if possible you may want to eventually transfer ownership of the 529 account to the parents just before your grandchild starts college.
Original Post 2014-09-18, Updated 2018-11-05
A good place to start