Having a 529 plan is great way to prepare for future education costs. It encourages savings and provides tax advantages. It’s important to be clear on three areas:
- Who owns the 529 plan?
- How the 529 funds are used?
- When the 529 funds are used.
Getting it right (or wrong!) can have a dramatic impact on the amount of financial aid that’s available to a student.
For example, if the 529 plan is reported as a parent asset on the FAFSA (Free Application for Federal Student Aid), it’ll reduce need-based aid by as much as 5.64% of the 529 value. If the plan is owned by anybody else, such as a grandparent, eligibility for need-based financial aid will be reduced by as much as 50% of the distributed amount!
How Can I Avoid This?
In my last blog post, FAFSA: An Investment in the Future, I listed two strategies grandparents can use to avoid this reduction in financial aid. Let’s dive into more details on the two strategies and learn about a couple more.
- Put the parents in charge. Fill out paperwork to change the account owner to the parent. Unfortunately, there are a few 529 plans that do not allow this. Be sure to consult with your tax professional before changing. Some states will recapture state income tax benefits if the account owner is changed.
- Rollover funds from grandparents to parents. (This can be a win-win strategy!) The grandparent can roll over a year’s worth of expenses from the grandparent-owned 529 to a parent-owned 529 plan. Just make sure the roll over happens in the same state.
- If you don’t need the funds immediately, wait. Even though the natural tendency is to use the funds from a 529 plan in the student’s first year, you can choose to wait. Will the student graduate in 4 or 5 years? Wait until January 1 of the student’s sophomore year for a 4-year grad and January 1 of the junior year for a 5-year grad.
- Use the funds for a different purpose. Did you know you can use the 529 to pay off student loans? A grandparent make the funds a gift upon graduation. The drawback to this strategy is any distributions may be subject to additional taxes.
The earlier you start planning for long-term expenses like a college, the better. It’s normal to be overwhelmed by all of the choices available for college savings. If your plan isn’t 100% perfect now, you can always make these changes.
As a grandparent, you want the best for your grandchildren. The more money you contribute, the more important account ownership becomes. As long as you trust the parents to handle the college funds, you’ll make things easier by allowing them ownership. Taking the time now to clear up the account details will put your grandchildren on the path to higher education and future success.