Can a Grandparent Contribute to a 529 Plan and Claim a Tax Deduction?

Saving for a grandchild’s education is a meaningful way to support their future, and 529 plans are a popular tool for this purpose. These tax-advantaged accounts allow funds to grow while being used for qualified education expenses. Grandparents contributing to a 529 plan may wonder whether they can also benefit from tax deductions or other incentives.

Tax treatment of contributions depends on federal and state rules, as well as how the account is structured. Understanding these factors can help maximize both savings and potential tax benefits.

Federal Treatment of 529 Contributions

The federal government does not offer a tax deduction or credit for 529 contributions, regardless of who makes them. Unlike IRAs or 401(k)s, where contributions reduce taxable income, 529 plans are funded with after-tax dollars. Their primary benefit is tax-free growth and withdrawals when used for qualified education expenses.

Earnings grow tax-deferred, meaning there are no annual taxes on interest, dividends, or capital gains. When withdrawn for eligible expenses—such as tuition, fees, books, and certain room and board costs—these funds remain free from federal income tax. This tax-free treatment allows contributions to compound over time, making early contributions particularly effective.

While contributions do not reduce taxable income, they are considered completed gifts for tax purposes. In 2024, individuals can contribute up to $18,000 per beneficiary without triggering gift tax reporting under the annual exclusion limit. Grandparents can also use a five-year election to contribute up to $90,000 at once and spread it over five years for tax purposes, avoiding gift tax consequences.

State Tax Deductions and Credits

Many states offer tax deductions or credits for 529 plan contributions, but eligibility and benefits vary. Over 30 states, including New York, Illinois, and Virginia, provide a state income tax deduction for residents contributing to their home state’s plan. For example, New York allows a deduction of up to $5,000 per year for single filers and $10,000 for married couples filing jointly, provided they contribute to the New York 529 College Savings Program.

Some states, such as Indiana and Utah, offer tax credits instead of deductions. Indiana provides a 20% tax credit on contributions, capped at $1,500 per year. A grandparent contributing $7,500 to an Indiana 529 plan could receive the full credit. Unlike deductions, which reduce taxable income, credits directly lower the amount of tax owed.

Residency requirements often apply, meaning tax benefits are usually limited to those contributing to their own state’s plan. However, a few states, including Arizona, Kansas, and Pennsylvania, allow residents to deduct contributions to any state’s 529 plan. This flexibility means a grandparent in Arizona could contribute to a grandchild’s plan in another state while still claiming a deduction on their Arizona tax return.

Some states impose additional conditions. Minnesota offers both a deduction and a credit but limits the credit based on income. Michigan and Wisconsin require the contributor to be the account owner to qualify for a deduction, which could affect a grandparent’s ability to claim tax benefits if they contribute to a parent-owned plan.

Contribution Limits and IRS Rules

Each 529 plan has a maximum aggregate limit set by the state sponsoring the plan, dictating the total amount that can be contributed per beneficiary. These limits vary significantly, ranging from around $235,000 in Georgia to over $575,000 in California and New York. Once an account reaches the state’s cap, no further contributions are allowed, though earnings can continue to grow.

The IRS does not impose an annual contribution limit on 529 plans, but large contributions may have gift tax implications. While anyone can contribute, account ownership rules vary by state. Most states allow parents, grandparents, and other relatives to serve as account owners, but only the owner controls withdrawals and beneficiary changes. Some states require the account owner to be a resident of the sponsoring state, though contributions can typically be made by anyone, regardless of residency.

If funds are withdrawn for non-qualified expenses, the earnings portion is subject to income tax and a 10% federal penalty. Some states impose additional penalties or require repayment of previously claimed tax deductions. Exceptions to the federal penalty include cases where the beneficiary receives a scholarship, attends a U.S. military academy, or becomes disabled. In these situations, the withdrawal is subject to income tax but not the 10% penalty.

Gift and Estate Tax Implications

Grandparents contributing to a 529 plan should consider how these gifts fit within their estate planning. Contributions are treated as completed gifts under federal tax law, reducing the contributor’s taxable estate while benefiting the grandchild. The IRS allows individuals to give up to $18,000 per recipient in 2024 without triggering gift tax reporting.

A useful strategy is the five-year gift tax averaging election, which allows a grandparent to contribute up to $90,000 in a single year and spread it evenly over five years for tax reporting purposes. This accelerates funding while avoiding immediate gift tax consequences. However, if the contributor passes away before the five-year period ends, any remaining portion of the gift is included in their taxable estate. Proper documentation on Form 709, the U.S. Gift Tax Return, is required to elect this treatment.

Ownership and Control Considerations

Deciding who owns a 529 plan affects financial aid eligibility, tax benefits, and control over the funds. While anyone can contribute, only the account owner can make investment decisions, change beneficiaries, and withdraw funds. Grandparents who want control over their contributions may prefer to open and own the account themselves rather than contribute to a parent-owned plan.

A grandparent-owned 529 plan does not count as a parental asset on the Free Application for Federal Student Aid (FAFSA), which can be beneficial for financial aid calculations. Prior to recent changes, withdrawals were considered untaxed student income, potentially reducing aid eligibility by up to 50% of the withdrawal amount. New FAFSA rules, effective for the 2024-25 academic year, have eliminated this penalty, making grandparent-owned plans more attractive. Some private colleges using the CSS Profile may still consider these distributions in their aid calculations.

Accessing and Using Funds

Funds in a 529 plan must be used appropriately to maximize tax advantages and avoid penalties. Qualified education expenses include tuition, fees, books, supplies, and room and board for students enrolled at least half-time at an eligible institution. Recent rule changes allow up to $10,000 per year to be used for K-12 tuition and up to $10,000 in lifetime student loan repayments per beneficiary.

If funds are withdrawn for non-qualified expenses, the earnings portion is subject to income tax and a 10% penalty. Exceptions include cases where the beneficiary receives a scholarship, attends a U.S. military academy, or becomes disabled. In these situations, the penalty is waived, though income tax still applies to the earnings.

If a grandchild does not need the funds, the account owner can transfer the balance to another qualified family member without tax consequences. This flexibility ensures that the money can still be used for education, even if the original beneficiary does not require it.