Should a 529 Plan Be in a Grandparent’s Name?

A 529 plan is a state-sponsored investment account designed to help families save for education. Contributions can be invested, and any earnings grow free from federal income tax. Withdrawals are also federally tax-free when used for qualified education expenses.

The primary purpose of a 529 plan is to cover educational expenses, including tuition and fees at colleges and universities. Qualified expenses also include costs for certain apprenticeship programs, and up to $10,000 per year for K-12 tuition. Federal rules also allow a lifetime limit of $10,000 to be used for repaying qualified student loans. Funds can also be rolled over to a Roth IRA for the beneficiary, subject to a lifetime maximum of $35,000, provided the 529 account has been open for at least 15 years.

Any adult can open a 529 plan and name a beneficiary, such as a grandchild. There are no income limitations for the person opening the account, and anyone can contribute to it.

Financial Aid Considerations

How a 529 plan impacts a student’s financial aid eligibility is a significant factor for families, and recent changes have altered the landscape. The FAFSA Simplification Act, effective for the 2024-2025 award year, has changed how assets in a grandparent-owned 529 plan are treated. This update removed a long-standing obstacle that previously made these plans less favorable.

Under previous rules, assets in a grandparent-owned 529 plan were not reported on the Free Application for Federal Student Aid (FAFSA), but distributions were. When a grandparent paid for college costs, the money was counted as untaxed income to the student. This student income could reduce aid eligibility by up to 50% of the amount distributed.

Under the new FAFSA rules, distributions from a grandparent-owned 529 plan are no longer reported as student income. This means a grandparent can pay for qualified education expenses directly from the account without diminishing the student’s potential for need-based financial aid. This change aligns the treatment of grandparent-owned plans with parent-owned plans.

However, hundreds of private colleges and universities use an additional form, the CSS Profile, to award their own institutional aid. The CSS Profile may still ask about distributions from grandparent-owned 529 plans, which could be factored into their financial aid calculations.

This shift makes a grandparent-owned 529 a more attractive strategy for federal aid purposes. Families no longer need to use complex workarounds, such as waiting until the student’s final years of college to use the funds or transferring ownership to a parent, to avoid the previous income penalty.

Tax and Estate Planning Implications for the Grandparent

Contributions to a 529 plan are considered completed gifts for tax purposes. This allows a grandparent to give up to the annual federal gift tax exclusion amount, currently $19,000 per individual, to each grandchild’s 529 plan without needing to file a gift tax return.

A feature of 529 plans is the ability to accelerate gifting through “superfunding.” This provision allows a contributor to make a lump-sum contribution equivalent to five years of annual gifts at one time. An individual grandparent can contribute up to $95,000 per beneficiary in a single year, and a married couple can contribute up to $190,000, without triggering the gift tax.

Moving assets into a 529 plan can also benefit a grandparent’s estate plan. The funds contributed are generally removed from the grandparent’s taxable estate, which can help reduce or eliminate potential estate taxes. Despite the money being removed from the estate, the grandparent retains full control over the account as the owner, a feature not common with other irrevocable gifts.

While contributions to a 529 plan are not federally deductible, many states offer their own tax benefits, such as an income tax deduction or credit for contributions. This benefit is usually available only to residents who contribute to their home state’s plan.

Account Management and Ownership Rules

The account owner, in this case the grandparent, has complete authority over the assets in a 529 plan. The grandparent dictates all investment decisions and authorizes all withdrawals, ensuring funds are used as intended. This control means the beneficiary cannot access the money independently.

Managing a grandparent-owned 529 plan should include planning for succession. The grandparent should name a successor owner, often one of the beneficiary’s parents. If the grandparent passes away without a successor named, the account may become part of their probate estate, which can lead to delays and legal complications in accessing the funds.

The rules for 529 plans provide flexibility regarding the beneficiary. If the original grandchild does not pursue higher education, receives a full scholarship, or has leftover funds, the grandparent is not locked in. As the account owner, they can change the beneficiary to another eligible family member, such as another grandchild or even themselves, without incurring taxes or penalties.

An eligible family member is broadly defined and includes siblings, parents, cousins, and other relatives of the original beneficiary. This feature prevents the money from being stranded if the initial beneficiary’s plans change.