You’ve probably heard the statistics: student loan debt has reached an all-time high in our country and isn’t showing any signs of slowing. In fact, total student loan debt in the U.S. has reached a staggering $1.4 trillion. That means the average student in the graduating class of 2016 had about $37,172 of debt fresh off the stage after receiving their diploma. This national crisis, coupled with the benefits of pursuing higher education, has pushed parents and grandparents to start saving for their heirs as early as possible.
The Benefits of 529 Plans
Enter 529 plans. These financially savvy solutions offer tax-advantaged savings when paying for higher education. A 529 plan is sponsored by a state or state agency and allows a person to grow their savings on behalf of a beneficiary, who could be a child or a grandchild. Earnings grow tax deferred and when funds are used for qualified higher education expenses the distribution is not subject to federal taxes (and generally not state taxes). Additionally, beginning in 2018, up to $10,000 in annual expenses for tuition can be used for elementary or secondary public, private, or religious schools.
How Grandparents Can Help
In some cases, cash-strapped parents must rely on the generosity of grandparents to fund a 529 plan for the student. Grandparents can own, fund, and designate their desired beneficiary. While this is certainly a smart way to save for future college costs, there are some important drawbacks to a grandparent owning the plan.
Things To Keep In Mind
So what’s the big deal? The inherent answer is nothing, initially. A grandparent simply owning the account does not reduce or affect the student’s ability to receive financial aid. However, the problem arises when a distribution is made for the first year of college.
- When a grandparent owns the plan, a distribution is considered to be the student’s income.
- When a parent owns the plan, a distribution is considered to be the parent’s income.
This is an important distinction because the FAFSA®, the Free Application for Federal Student Aid, designates a larger weighting on student income than parent income. The result of a grandparent making a qualified distribution is that the student becomes less eligible to receive federal student aid than if the parent owned the plan and made a distribution.
This little-known distinction can be mediated by changing the owner of the plan from the grandparent to parent. Grandparents can even make this change without incurring a tax consequence because merely changing ownership of the plan is not considered a gift. Only when a distribution is made from the account will there be tax implications.
So parents and grandparents: be careful. College flies by, but don’t let a planning opportunity do the same.
From the desk of Courtney Stutts
Dislcosures: Before investing, the investor should consider whether the investor’s or beneficiary’s home state offers any state tax or other benefits available only from that state’s 529 Plan.College Planning, Investing & Saving