Updated Rules Make Grandparent Owned 529’s More Attractive

74951571Key Takeaways:

  • New tax law change makes grandparent-owned 529 plans more attractive than ever.
  • Grandparent-owned 529 plans can now be used to fund the final two years of college–not just the final year–with no detrimental impact on the grandchild’s financial aid package.
  • Consider all of your college savings options carefully before investing. Don’t hesitate to ask a financial advisor for guidance.

We’ve written previously about the advantages of using 529 college savings plans to help finance the high cost of your child’s or grandchild’s higher education (see here and here).  We have also written about the fact that 529 plans–technically known as “Qualified Tuition Programs” under Section 529 of the Internal Revenue Code—were often an inefficient way for grandparents to help finance a grandchild’s college tuition. That is because unlike a parent’s contribution to a 529 plan, a grandparent’s contribution (or any other non-parent for that matter) to a 529 plan could greatly reduce the amount of financial aid a child was potentially eligible for. Here’s why:

On the Free Application for Federal Student Aid (FAFSA), 50 percent of withdrawals from a grandparent-owned 529 plan that were used to pay for a student’s schooling were essentially included as the student’s income. As a result, this hurt the student’s ability to maximize their financial aid. By comparison, withdrawals from a parent-owned 529 plan added only up to 5.64 percent to the amount of the student’s income (referred to as Expected Family Contribution, or EFC) on the FAFSA.

But thanks to a recent law change, 529’s are now a more attractive option for grandparents who are looking to help finance the younger generation’s sky high college costs.  As summarized in a recent Forbes article, “the FAFSA for the 2017-2018 academic year will look to student and parent income from the 2015 calendar year, as opposed to the 2016 calendar year.”

So what does this all mean?

Well before the recent tax change, the best way for a student to use a grandparent-owned 529 plan AND still qualify for the maximum amount of financial aid, was to use grandparent funds in the student’s final year of college only. Why? Because the FAFSA looked at prior year income when determining financial aid for the current year.  If funds were used before the final year of college, then 50% of the amount withdrawn was added to the student’s EFC. That often resulted in a potentially significant reduction in financial aid.

The 529 landscape has changed

But now, students can use the funds in a grandparent-owned 529 plan for the final two years of college—not just the last year–with no detrimental effect on their financial aid eligibility. This is because withdrawals from grandparent owned 529 plans are considered income to the student when calculating financial aid for the next school year.  But if the FAFSA is now only looking at income from 2 years ago, a student can withdrawal from a 529 plan in their final two years of college without any effect on financial aid.  The change essentially doubles the impact of grandparent contributions. Now grandparents who are looking to help defray a grandchild’s college expenses can look to a 529 plan as a possible solution–and potentially receive a state tax deduction for their generosity! This can be more advantageous than paying the college directly as we discussed in a previous post.

Conclusion

While this law change makes the 529 plan an attractive option, please make sure you fully understand the benefits and costs of each college savings vehicle before investing. If you are considering your college savings options, please feel free to contact me if you have questions and would like to discuss in more detail.

About Patrick Runyen

As a Wealth Manager at Independence Advisors, Patrick Runyen, CPA/PFS, CFP® works closely with clients to implement wealth management solutions. He leverages his technical financial planning and consulting experience to assist clients with investment counseling, retirement planning, estate planning, wealth enhancement, asset protection, tax planning, and other personally significant financial decisions. CLICK HERE TO ASK PAT.

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