Can I Open a 529 for My Grandchild?

A 529 plan serves as a tax-advantaged savings vehicle designed to help families save for future education expenses. These plans are sponsored by states and educational institutions, offering a structured way to accumulate funds for various post-secondary training, college, and even K-12 education costs. The primary appeal of a 529 plan lies in its potential for tax benefits, enhancing savings over time. These plans are broadly accessible for various educational pursuits.

Establishing a 529 Plan for a Grandchild

Grandparents can indeed establish a 529 plan for their grandchild, providing a direct means to contribute to their educational future. When a grandparent opens such an account, they typically become the account owner, while the grandchild is designated as the beneficiary. As the account owner, the grandparent maintains control over the assets, including investment decisions and the ability to change the beneficiary.

These plans are state-sponsored, and account owners can select a 529 plan from any state, choosing a program that best aligns with their financial goals and preferences. The two main types of 529 plans available are college savings plans and prepaid tuition plans, with college savings plans generally offering more flexibility in terms of eligible expenses and school choice. Opening a 529 plan requires personal details for both the account owner and beneficiary. This information includes full names, addresses, dates of birth, and Social Security or Taxpayer Identification Numbers. Gathering these details streamlines the application process.

Contributions and Tax Benefits

Contributions to a 529 plan can be made by anyone, not solely the account owner, through methods such as lump-sum payments, recurring direct deposits, or checks. These contributions are considered gifts under federal tax law and are subject to annual gift tax exclusion limits. For 2024, an individual can contribute up to $18,000 per beneficiary without incurring federal gift tax consequences; this amount increases to $19,000 for 2025.

A special provision allows for an accelerated gift, where an individual can contribute up to five years’ worth of contributions at once, totaling $90,000 in 2024 or $95,000 in 2025, by electing to spread the gift over five years. This strategy can remove a substantial amount from the grandparent’s taxable estate. Earnings within the account grow tax-deferred at the federal level, meaning taxes on investment gains are postponed until distributions are made. Furthermore, when funds are withdrawn for qualified education expenses, these distributions are entirely free from federal income tax.

Many states also offer income tax deductions or credits for 529 contributions, though these state-specific benefits typically apply only if contributions are made to the 529 plan sponsored by the contributor’s home state. The account owner retains control over the funds and can change the beneficiary to another eligible family member without tax penalties. The IRS provides a broad definition of an eligible family member, ensuring funds can still serve an educational purpose even if the original beneficiary’s plans change.

Using 529 Funds for Education Expenses

Funds from a 529 plan can be withdrawn tax-free at the federal level when used for qualified education expenses at eligible educational institutions. Qualified expenses include tuition and fees, room and board for students enrolled at least half-time, and the cost of books, supplies, and equipment.

The definition of qualified expenses has expanded to include K-12 tuition, with up to $10,000 per student per year eligible for tax-free withdrawals. Expenses for registered apprenticeship programs, including fees, books, supplies, and equipment, also qualify if the program is certified by the U.S. Department of Labor. Up to a lifetime limit of $10,000 per individual can be used to repay qualified student loans for the beneficiary or their siblings.

Distributions used for purposes other than qualified education expenses are considered non-qualified withdrawals. The earnings portion becomes subject to federal income tax and typically a 10% federal penalty tax. Some states may also impose their own taxes and penalties. The account owner maintains control over distributions, helping ensure funds are used appropriately. If a grandchild does not pursue higher education, the account owner has several options for the remaining funds. The beneficiary can be changed to another eligible family member, allowing the funds to be used for another individual’s education. Another option, under specific conditions, is to roll over up to $35,000 from the 529 plan into a Roth IRA for the beneficiary, provided the 529 account has been open for at least 15 years and certain contribution holding periods are met.

Impact on Financial Aid Eligibility

The treatment of grandparent-owned 529 plans on financial aid eligibility has undergone changes. Unlike parent-owned 529 plans, the assets held within a grandparent-owned 529 plan are generally not considered an asset of the student or parent on the Free Application for Federal Student Aid (FAFSA). This distinction can be beneficial for families seeking need-based financial aid.

Historically, distributions from grandparent-owned 529 plans were reported as untaxed student income on the FAFSA, which could substantially reduce a student’s eligibility for financial aid in subsequent years. However, starting with the 2024-2025 academic year, the FAFSA Simplification Act means distributions from grandparent-owned 529 plans are no longer reported as student income on the FAFSA. This change eliminates a previous disincentive for grandparents.

This update means that a grandparent’s contributions and subsequent distributions from a 529 plan will not negatively impact a grandchild’s federal financial aid eligibility. While federal financial aid rules have become more favorable, some private colleges using the College Scholarship Service (CSS) Profile may still request information about 529s owned by relatives. It is advisable to consult with a financial aid advisor for personalized guidance, as institutional aid rules can vary.