When grandparents want to help pay for a grandchild’s education, they can choose a method that is just as beneficial to them as it is to their grandchild. With smart planning, grandparents can save taxes using a tax-preferred vehicle like a 529 plan. If they choose a 529 plan, it is important to understand the implications of having grandparents as owners instead of the child’s parents.
Tax-deferred 529 plans have an account owner and a beneficiary. Typically, a parent is the account owner and a child is the beneficiary. This allows the parent to retain control over the account, preventing the child from making poor decisions with the money, like buying a new car. When determining financial aid eligibility, it is usually better for a parent to be the owner of the 529 account. While this calculation can get complicated, in general, parents are expected to contribute 5.64% of their eligible assets annually towards their child’s tuition. Retirement assets are not counted. The student is expected to contribute 20% of her assets. This is why it is typically recommended to spend down the child’s assets first, if they have any. Grandparents’ assets don’t count at all. So why would you not have the grandparent set up a 529?
The catch is this: If a distribution is taken from a grandparent owned 529, the distribution amount needs to be reported as income on the student’s financial aid form the following year. This can reduce the student’s financial aid amount by up to 50% of the distribution amount. So if $10K was distributed, the aid amount can be reduced by as much as $5K. If financial aid is not a possibility in your situation, this nuance doesn’t matter. If it is a possibility, hold off on taking distributions from a grandparent owned 529 until the last FASFA form is filed, typically the middle of the student’s junior year.
Another way for grandparents to contribute is to simply gift money (within gifting limits) to the parents to be used for college. It will affect the aid amount since it is the parent’s asset as discussed, but not by much. Here are some more pros and cons to having a grandparent owned 529. Be sure to consult with your financial and tax advisor to understand what is best for your specific situation.