Plans help fund grandchildren's college



Dear Joe, I would like to set up an account to which I could contribute money on birthdays and holidays for my grandchildren's future education. Would you recommend a savings account, money market, stocks or bonds? Thank you. -- Diane


Dear Diane,

You have several options for funding a child's future education, but I think the 529 plan works best for most grandparents. A 529 plan is a state-sponsored investment program designed specifically for college. Investments can be withdrawn free of federal taxes when used for the beneficiary's qualified higher-education expenses. Most 529 plans offer a variety of investment options, including the types of investments you've mentioned.

The first step is to find out if your children have already opened up 529 accounts for your grandchildren. If they have, you typically can contribute directly into those accounts as long as you have the 529 plan's account number, name and address.

It's important to note that a few states do not accept contributions from anyone other than the account owner. If you find this to be the case, make your gift to the parents and request they deposit the funds into the 529 plan.

If your children have not already established 529 accounts for your grandchildren, perhaps asking for an account number will spur your kids to do so. Or, you can establish your own 529 accounts for the grandchildren.

The primary difference between the two approaches relates to the future ownership and control of the accounts. A grandparent making large contributions will often decide to retain control by being the account owner, while a grandparent making relatively small and sporadic contributions may decide it is easiest to use the parents' 529 accounts.

Grandparent-owned 529 accounts have a slight advantage when it comes to determining a student's federal financial-aid eligibility.

A Coverdell education savings account, or ESA, is another tax-free college savings vehicle offered by many banks, mutual fund firms and investment brokers. However, a child must pay a penalty tax if contributions to an ESA from all sources exceed $2,000 in a year. So, if someone else, such as the parents, makes ESA contributions, you should not.

Another common approach is to give your grandchildren direct gifts of cash along with a personal request that the money be invested and used for their future education. It will be up to their parents, as custodians, to establish a Uniform Transfers to Minors Act, or UTMA, and decide where to invest the money.

Although modest amounts in a UTMA may not cause any problems, large balances can create several concerns. These include the so-called kiddie tax (designed to prevent parents from sheltering income by hiding it in their child's name), the significant impact of student-owned investments on the child's ability to qualify for financial aid, and the risk that the child will take the money at age 18 or 21 and use it for less-than-desired purposes.

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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Coverdell ESA vs. 529 Plan: Which to choose? (Script)

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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Top 529 Plan Withdrawal Tips. (Script)

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Top 529 Plan Withdrawal Tips. (Video)

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