The cost of college has increased so much that many families rely on two generations to help cover expenses.
There are parents, who are increasingly saving in 529 university savings plans, where earnings are tax-free if used for qualified education expenses. Then there are the grandparents, who are joining the mission to take the children to college with less debt. They too are saving in 529 floors.
Here is the problem Many grandparents worry that their 529 contributions will negatively affect their grandchildren in the process of federal financial aid.
The free application for Federal Student Aid (FAFSA) examines income and assets for parents and students. A 529 owned by a grandfather is not reported on the FAFSA.
But once the money has been withdrawn from a 529 due to grandparents and used to pay for college expenses, it is considered income for the student and must be reported to the FAFSA. Because up to 50% of a student's income is considered available for college, the money used by a grandparent's 529 can reduce aid by at least half of the amount of the distribution.
There are ways for grandparents to manage 529 withdrawals to minimize the impact on financial aid.
– Instead of opening 529 themselves, grandparents can contribute to a parental ownership plan 529, which reduces the eligibility for financial needs-based assistance to only 5.64 percent of the assets' net assets.
– Grandparents can open an account and collect state tax deductions for themselves. But when it comes time to withdraw money, they can transfer ownership to a parent. Be sure to check first with the finance company that manages the 529 plan to confirm that you can change ownership and / or that there are no tax consequences in doing so.
– Families can use their grandparents' 529 money last. The FAFSA uses the tax information two years ago. So grandparents can wait until after 1 January of the second year to take a distribution and will not influence the FAFSA of the next year, taking on graduate students in four years, says Mark Kantrowitz, editor and vice president of research for Savingforcollege.com, a website created to help families understand 529 plans.
Kantrowitz said that if it takes a five-year-old student to graduate, then grandparents can wait until January 1 of the junior year to take a distribution. During a recent online discussion, I invited Kantrowitz to answer questions on 529 plans.
D: My in-laws are making 529 contributions for my three children. At some point, my in-laws will pass, and I hope this happens long after my children have left college. But if it's before I start college, is there anything my husband and I have to do to make sure children have access to these funds?
Kantrowitz: A 529 plan has an account holder and a payee (the child). There are three typical scenarios involving grandparents and 529 plans:
– The grandfather is the owner of the account and the nephew is the beneficiary.
– The parent is the owner of the account and the nephew is the beneficiary.
– The nephew is the owner of the account (a custody account) and the beneficiary, with the grandfather acting as custodian until the nephew reaches the age of majority.
If grandparents are the owners of the account, ask them if they have specified a successor, in case they pass. If they do not, suggest to appoint you or your spouse as a successor.
D: If grandparents are holders of a 529 account and transfer the property to the parents to reduce the effect on the aid, is this the same as taxable income for the parents for that year?
Kantrowitz: Generally, a change in the account owner or in the rollover of a 529 plan is excluded from federal income. At the state level, it depends on the law of the state. Some states negotiate a shift to a non-state 529 plan such as an unqualified distribution, which will subdivide the portion of earnings to income taxes at the payee's rate, plus a 10% tax penalty, in addition to the recapitulation of tax income benefits State. So it is better to move from a grandparents '529 plan to a 529 property plan owned by the parents in the same state as the grandparents' plan 529.
Singletary: I understand the concern about how the FAFSA rules deal with the 529 grandparent-owned distributions. Many wonder if it is worthwhile to finance a 529 for their grandchildren. They worry that they are hindering free money.
However, if the alternative is not to save, this makes no financial sense. Much of the help based on need is in the form of loans. And, as I have repeatedly reported, most students do not get enough scholarships – based on necessity or merit – for a complete tour of college. So there will be a gap and savings in a 529 plan can help fill it.