Grandparents Should Consider Financial Aid When Contributing to 529 Plans

Jane Young, CFP, EA

Jane Young, CFP, EA

With the high cost of college many grandparents want to help their grandchildren with college.   One of the best ways to accomplish this can be through the use of 529 plans.

A 529 plan allows you to invest money for college with tax free earnings and tax free withdrawals, as long as the money is used for qualified higher education expenses.  Your grandchildren can use this money at any eligible post-secondary institution.  In Colorado your 529 contribution is deductible on your state income taxes.  Additionally, the owner of a 529 plan can change the beneficiary of a 529 plan as the needs of grandchildren change.

There are special gift tax benefits when contributing to a 529 plan.  The current annual gift tax exclusion is $14,000.  This means that both grandparents can gift up to $14,000 to each grandchild.  Additionally, with 529s you can make a one-time contribution of up to $70,000, if you treat the contribution as if it were made over 5 years.

Unfortunately, if your grandchildren are eligible for need based financial aid, utilizing a 529 plan for your grandchildren’s college expenses can hurt their chances of getting financial aid.  The amount invested in the 529 is not reported on the FAFSA (Free Application for Student Aid) but payments made to cover college expenses are included in the student’s income.  This income will reduce the student’s financial aid by 50% of the amount of the payment.

To avoid this problem you can transfer ownership of the 529 to the parent’s name before the student applies for financial aid.  For financial aid purposes a parental 529 is considered an asset and only 5.64% of the value is considered when calculating needs based aid.  About a dozen states do not allow transfer of ownership on 529 plans – ownership transfers are allowed in Colorado.

Alternatively, you could initially contribute to a parental 529 plan but you would lose the state income tax deduction and you lose control of the account.  The owner of the 529 account can change beneficiary designations and can spend money from the account, subject to a 10% penalty if not used for qualified college expenses.  Loss of control could be a concern in the case of divorce or blended families.

Another way to avoid an adverse impact to financial aid is to delay use of the grandparent’s 529 until January 1st of the student’s junior year in college.  Contributions after this day will have no impact on the student’s eligibility for financial aid.  You won’t have to report the 529 as an asset on FAFSA and the contributions from the account are not reported as student income.   This is a viable option if the student has other resources to pay for college up to this point and they still have enough college expenses to use all of the funds in the 529 account.

Covering the High Cost of College Can Require Team Work, Diligence and Compromise

Jane Young, CFP, EA

Jane Young, CFP, EA

With soaring college expenses, few families can afford to cover the costs associated with putting their children through four years of college on top of daily living expenses and the need to save for retirement.   To avoid sacrificing your retirement savings and accruing large student loans, to finance your children’s college education, engage them in the process.  For most families, it is reasonable for the cost of college to be a shared responsibility between you and your children.

Start early by encouraging your children to get good grades, to participate in extracurricular activities, and to volunteer in the community.   While in high school, encourage your child to enroll in Advanced Placement and International Baccalaureate courses that provide high school and college credit.  Your child could have several college courses completed before graduating from high school.  This could save you thousands of dollars. 

Explore all forms of financial aid even if you think you may not be eligible.  You may be surprised, especially if you have several children attending college at once.  Additionally, do your research and be open-minded with regard to the colleges you consider.  Some schools that seem too expensive may have excellent financial aid packages for your situation.

If you find yourself in the common place where you earn too much for financial aid, but not enough to pay the full ride of four year college education, research the availability of merit scholarships.   While your child is still in high school, thoroughly research the availability of scholarships.  Talk to the high school guidance counselor and check with community organizations.  Once in college your child should talk to the financial aid officer, department heads and professors for potential scholarship opportunities.  Also check on-line resources including CollegeBoard.com, CollegeNet.com, and Fastweb.com.  Every year many scholarships go unused because qualified candidates don’t apply.  

Your child can dramatically decrease the cost of tuition by attending a community college for the first two years and then transferring to a four year university.  Many universities have arrangements with local community colleges to transfer credits earned toward the first two years of a bachelor’s degree.    The cost of tuition at a community college is usually less than one half of that at a four year university. 

Another way to reap tremendous savings is for the student to live at home and attend a local school.  In 2014 the cost of tuition and fees at the University of Colorado is about $12,600 and the cost of room and board is about $13,000. 

If after exploring the options above, the cost of college is still beyond your reach; your student may need to work while attending college.  To help pay for tuition, your student may need to work 30 hours a week and take a lighter class load.  Graduating in five years may be better than incurring huge student loans.

Saving for College with a 529 Plan

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Jane M. Young CFP,EA

A 529 Savings Plan is a tax advantaged college savings plan sponsored by a state or educational institution. The plan is named after section 529 of the Internal Revenue Code, created in 1996. Every state offers at least one 529 plan. Investment in a 529 plan enables the owner to save money, tax free, for future college expenses on behalf of a student or “beneficiary”. Although 529 plans are generally sponsored by specific states, they may be used at any eligible college, university, or trade school throughout the country.
Funds invested in 529 plans grow tax free if they are used for qualified education expenses. Qualified education expenses include tuition, required fees, room and board, required books, and required supplies. Although contributions are made with after tax dollars, residents of Colorado can deduct contributions made to the Colorado plan from their state income taxes.
The owner of a 529 plan has full control over the account. The owner has the freedom to select or change the beneficiary and select from the investment choices. Many find 529 plans preferable over custodial accounts for minors where the assets are held in the child’s name, and are irrevocable. Once funds are transferred to a custodial account, the funds must be used for the benefit of the minor. This can have unintended consequences. Here is an example, your daughter reaches the age of majority and decides she would rather have a corvette than a college education. Unfortunately, the money is hers to spend however she pleases.
Additionally, gains on custodial accounts are fully taxable. Custodial accounts can also be detrimental to financial aid because they are viewed as assets of the student. In comparison to a custodial account, a 529 plan has less impact on a student’s eligibility for need-based financial aid. A 529 plan is viewed as an asset of the parent rather than an asset of the student.
A common concern with 529 savings plans is your child may not need the funds for college expenses. Fortunately, if your designated beneficiary gets a scholarship or decides against a college education, you can change the beneficiary to another family member or to yourself. If you don’t need the money for college expenses, you can withdraw the money from the 529 plan. However, if the funds are not used for qualified education expenses you will have to pay a 10% penalty and taxes on the gains. This in not entirely bad, you have a lump sum of money that may have been spent years ago, if you weren’t saving for college.
Investing in most 529 plans is simplified by using age weighted portfolios. These portfolios gradually transition into less risky investments as the beneficiary reaches college age.
When purchasing a 529 plan, be aware of high fees and commissions. Most states offer direct programs that don’t charge sales commissions. Colorado offers the choice of an inexpensive program directly through Vanguard, without a sales load.