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.

Leave a Reply