If you’re a grandparent helping to save for your grandchild’s education, you’re not alone. Recent surveys showed that nearly 40% of grandparents make some contribution to their grandchild’s college education. 529 college savings plans, where earnings are tax free if used for qualified higher education expenses, are becoming increasingly popular with parents and grandparents alike. If you are a grandparent (or soon to be one) here are a few things to consider when planning to help with college costs using a 529 plan.
Early savings is key
Many grandparents understand the value of time,and the impact it has on savings with compound interest. It’s simple; starting to save early gives more time for money to grow. Saving for college is a great example of patiently investing for a known future event. One good rule of thumb is the Rule of 70, which says the number of years it takes to double your money is 70 divided by the annual interest rate. So starting early is key. Another key: don’t delay the start of a savings program. If you save $1,000 for a one year old and earn 4%, you’ll have $1,972 at age 18. If you wait to start that savings program an age 5, you will only have saved $1,681 By helping to start a college savings plan, grandparents can make a big difference for long-term college savings, increasing college options and minimizing student debt for their grandchildren.
Utilize the special 5 year 529 gifting rule for estate planning purposes
Grandparents should consider utilizing their estate plans to kickstart college savings. Up to $15,000/year in 529 contributions can be made without triggering any gift taxes, considering the annual gift exclusion rule from the IRS. Under the special five year accelerating gifting rule available to 529 savers, grandparents can each gift as much as $75,000 toa 529 plan beneficiary in a single year, but this would require no subsequent gifts over the next 5 years in order to average out a $75,000 lump sum within the $15,000 guideline. Utilizing this rule and infusing a large amount now may make a huge difference in the amount available in the future for college tuition. This strategy may be particularly effective for people with grandchildren quickly approaching the college years. Checking with your financial advisor or tax advisor may also be a good strategy.
Be aware of financial aid policy; Use grandparent owned 529 accounts in junior and senior year of college
Grandparent assets are not directly disclosed on the Free Application for Federal Student Aid (FAFSA) since they are neither the custodial parent nor the student assets, obviously. However, when distributions from grandparent 529s are made to the student, the money is treated as “income” to the student for financial aid purposes in the year it was received. And here’s the tricky part: this additional income may actually decrease the student’s need-based financial aid eligibility. According to the federal formula, income earned by the student is considered to be available to pay for college at a much higher percentage than savings.
Wise planners look ahead to determine if the student would likely qualify for need-based funding based on the custodial parent’s household income. You will find My College Corner’s financial aid calculator useful for this purpose. It’s generally beneficial for grandparents to wait until at least junior year before distributing 529 savings to their grandchildren. This is another important nuance based on the federal financial aid formula. Federal financial aid eligibility is calculated using income and asset information from tax returns going back two years, a.k.a “prior-prior” year tax returns. So students applying for financial aid in 2019 use tax returns from 2017. Therefore any “income” they earn from the distribution they get from the grandparent’s 529 will not appear on the tax returns used to determine need-based eligibility for junior and senior year.
By holding off distributions from grandparent 529s until junior year, studentscan maximize their eligibility for need-based financial aid for the early years and then use the 529 fortheir last two years of college. Or the 529 funding could be used to pay for Graduate school, where financial aid is made up primarily of loans.
In any case, if there are excess funds, grandparents have options. They can change the beneficiary, or opt to pay a penalty for a non-qualified distribution from the plan.
Grandparents who help their grandchildren pay for college afford them an opportunity to graduate from college with as little student debt as possible. As we like to say at My College Corner: saving a dollar today is better than borrowing one tomorrow.