A four-year college education is expensive. Based on research by the College Board*, the published average annual cost of tuition and tuition fees for 2019-2020 at a four-year private college was $36,880. Tuition fees for in-state students at a four-year public school were on average $10,440 per year. Room and board are another charge. And if history is any guide, college is unlikely to get any less expensive over time.
As a grandparent (or close relative in a child’s life), what better gift could you give than the opportunity to graduate from college? One tax-advantaged way to help fund the cost of college is through a Section 529 plan. Here’s what you need to know about setting up this type of plan for a grandchild.
You Can Choose Which Plan You Use
Most Section 529 plans are state sponsored. They come in two varieties: prepaid tuition plans and college savings plans. You can set up a separate Section 529 plan for as many beneficiaries as you wish. You can fund the plans by investing a lump sum or by making regular contributions. You can contribute to a Section 529 plan regardless of your annual income or age. The Michigan Education Savings Program is the plan that the state of Michigan offers. But, if you prefer another state’s plan features, you can use them instead. It doesn’t matter where you or your grandchild live.
The money in a Section 529 plan grows on a tax-deferred basis, and distributions for qualified educational expenses are free of federal income tax. (Many states offer Section 529 plan tax benefits for their residents as well.) To avoid federal gift taxes on your plan contributions, you can limit them to the gift-tax annual exclusion amount ($15,000 per beneficiary in 2021; $30,000 if you and your spouse contribute) or elect to treat a larger contribution as though the gift was spread out over five years. By contributing, you are generally also removing the gift amount from your estate for federal estate tax purposes.
Impact on Financial Aid
Another advantage to opening a Section 529 plan on a grandchild’s behalf is that grandparent-owned Section 529 assets are not factored in to the Free Application for Federal Student Aid (FAFSA), which helps determine a student’s eligibility for grants, work-study programs, and loans. But be aware that up to 50% of any distribution made from a nonparent-owned Section 529 plan may count as income on a student’s future financial aid applications. (It may be possible to avoid this situation by delaying distributions from nonparent-owned accounts until the final two years of a grandchild’s college career.)
Make it a Family Affair
Opening the account while your grandchild is still very young will give your contributions the most opportunity to grow, thanks to the power of compounding interest. Since anyone can contribute to the account, you can encourage other friends and family members to help grow your grandchild’s account by contributing gifts of money for holidays, birthdays and special occasions.
In addition to Section 529 plans, there may be other options you can explore if you want to help pay for a grandchild’s education. It can make sense to work with a financial professional to determine what approach is best for your circumstances.
*Trends in College Pricing 2019, The College Board.
Investing in Section 529 plans involves risk, including loss of principal. Before you invest in a Section 529 plan, request the plan’s official statement and read it carefully. The official statement contains more complete information, including investment objectives, charges, expenses, and the risks of investing in a Section 529 plan, which you should carefully consider before investing. You should also consider whether your home state or your beneficiary’s home state offers any state tax or other benefits that are only available for investments in such state’s Section 529 plan. Section 529 plans are not guaranteed by any state or federal agency. By investing in a Section 529 plan outside of the state in which you pay taxes, you may lose the tax benefits offered by that state’s plan. Withdrawals used for qualified expenses are federally tax free. Tax treatment at the state level may vary.