529 in grandparent's name can be risky

By: Savingforcollege.com


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


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.

Popular Questions


Two kids, two 529 plans?

Dear Big Bill,
While it's possible to maintain a 529 plan in just one child's name, even when you intend to send more than one child to college, I generally recommend that families open a separate 529 account for each child.

That's assuming there is no additional cost to maintaining multiple accounts. If your 529 plan charges an annual or quarterly account maintenance fee, check to see if you can avoid the fee by signing up for automatic contributions through payroll deduction or electronic funds transfer)

With a separate 529 plan for each child, it becomes easier for you to tailor the mix of stocks, bonds and stable-principal investments (e.g., stable value, guaranteed principal and money market funds) to the particular ages of your children. When your older child is nearing high school graduation, you may want to ratchet down the level of market risk in her 529 plan. At the same time, you could keep a more-aggressive asset allocation in your younger child's 529 plan, accepting more risk for a potentially higher return. Many 529 plans offer "age-based" investment options that automatically make these adjustments as the beneficiary ages.

Separate accounts for your children also offer more gift-tax leeway. Since your 529 contributions are treated as gifts from you to the account beneficiary, your $15,000 (in 2018) annual gift exclusion will go twice as far with two accounts -- one for each child -- than with just one account.

Financial aid is another reason to recommend maintaining separate accounts. You wouldn't want the investments reserved for your younger child's future college expenses to count against your older child's financial aid eligibility. Be warned: The rules here are rather murky, and the impact of a sibling's 529 account may depend on the college's own policies as well on as the type of aid -- federal or institutional -- being sought.

Finally, I believe that separate 529 accounts allow for better family bookkeeping. There will never be any doubt as to your intention to help send all of your children to college. You'll avoid the uncomfortable position of being asked to explain to a curious 8th-grader why account statements are showing up in the mail with only a brother or sister's name on them. And in the event of your death or divorce, no matter how unlikely, your legal representatives and other family members will have less reason to question your actions in setting up and funding the 529 plans.

Even with separate accounts, you'll continue to have the flexibility to shift the money around in the future. You simply need to make sure that whenever funds are withdrawn from the 529 plan to pay for college they are coming from an account in the name of the child incurring the costs. It's a simple matter to change the beneficiary designation among family members at any time, transfer 529 funds between different family members' accounts or split one 529 account into two. The ability to move assets around the family is a key advantage of 529 plans when comparing other college-savings alternatives, such as Uniform Transfers to Minors Act, or UTMA, accounts.

Original Post: 2005-10-13
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The Coverdell ESA and the 529 plan are both excellent college savings vehicles because they are both tax-free when used for college. But many families face a choice: do they use a 529 plan for all of their child's college savings, or do they use a Coverdell for the maximum amount of $2,000 each year and put any any extra savings above $2,000 into a 529 plan? In spite of its low annual contribution cap, Coverdell's are now attracting quite a few families. There are two major reasons for that. One is that only the Coverdell allows you to self-direct your investments, just like you might self-direct the investments in your IRA. The other is that in addition to college expenses, Coverdells can be withdrawn tax-free to pay for a broad range of K-12 expenses, while 529 plans are limited to K-12 tuition. This feature is appreciated most in families planning to send their children to private grade schools, which may include additional costs such as room and board or uniforms. A 529 plan, on the other hand, does not impose age limits or income limits like the Coverdell does and so overall we see a lot more money going into 529 plans than into Coverdells. Plus many savers are happy with the investment choices offered by the 529 plans and don't necessarily want to self-direct their investments. And don’t forget this: your state may be giving you a state tax deduction for using a 529 plan, but there are no states offering a state tax deduction for investing with a Coverdell ESA.

Learn more about Coverdell ESAs.

Original post date 2013-07-15
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