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How Parents And Grandparents Can Use 529 Plans to Save for Education

Sara Gelsheimer  |  June 9, 2023

Saving for college? Here’s what you need to know about the different 529 plans available and the tax benefits associated with each option.

A 529 plan can be a great vehicle to save for education, and many individuals are taking advantage of these accounts. In fact, there are currently 15.81 million 529 accounts in the U.S. 

Still, it’s not always clear whether parents and grandparents should open 529 plans. Before you take the plunge, it’s important to understand the different types of plans available and the tax benefits associated with each option.

How Parents And Grandparents Can Save with 529 Plans

Also known as qualified tuition programs, 529 plans get their name from section 529 of the Internal Revenue Code. Each state except Wyoming has its own version of the 529 plan. Prepaid tuition plans and savings plans are the two primary types of 529 plans, allowing parents or grandparents to invest in either, depending on their particular needs.

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When funds are deposited into a 529 plan, their growth is exempt from federal taxes if used for qualified education expenses. After the 2017 Tax Cuts and Jobs Act, up to $10,000 per year per student can be withdrawn from a 529 plan for private K-12 tuition. There is no limit to the amount you can withdraw from a 529 for higher education (e.g., trade school, college, etc.).

Potential Benefits of 529 Plans for Parents and Grandparents

Some states offer tax advantages for contributions to 529 accounts, but the main benefit is that assets grow tax-free if they’re used for education. It pays to put money in early and give those funds more time to accumulate. I’ve worked with many grandparents who like to give a gift to a new grandchild. Putting that lump sum into a 529 for their benefit can be a great way to help the grandchild (and the parents!) — especially if that gift is given early in the child’s life and has time for substantial growth.

Another benefit of 529 plans is that anyone can contribute, regardless of income. Even those without high-paying jobs can help cover their children’s college costs by setting up 529 accounts and regularly contributing to them. Because there are no age limits on who can contribute to plans, even grandparents in their 80s or 90s are able to help. If the original beneficiary decides against college, funds may be transferred to another individual, often another grandchild, with no additional taxes owed, making it a great safety net for families.

With 529 plans, parents and grandparents may receive a state tax deduction (if the state in which they reside offers one), but only if they are the account owner. If a grandparent wanted to put money into an existing 529 (owned by the child’s parents), they would not receive the state tax deduction. Instead, the grandparent would need to open a separate 529 as the account owner (with the grandchild as the beneficiary) to take advantage of the state tax deduction. Sometimes, grandparents prefer simplicity over potentially small tax savings but should contact their financial advisor or tax preparer with questions.

It is important to note that 529 plans owned by grandparents are treated differently than those owned by parents. Recent changes to the FAFSA questionnaire make grandparent-owned 529s more advantageous. Previously, taking money out of a 529 owned by a grandparent was considered cash support for the purposes of calculating financial aid. Now, those gifts are not required to be reported, while 529 assets in the parent’s name are counted.

One additional benefit of a 529 is the ability to make up to five years of annual exclusion gifts in one year. For 2023, this equates to a gift of up to $85,000 per beneficiary (or $170,000 per beneficiary for married couples). This can be a great way for grandparents to shift assets without using any of their lifetime estate exemption amounts.

Potential Drawbacks of 529 Plans

The main drawback of the 529 is that it must be used for qualified education. If the child doesn’t pursue higher education or obtains a full-ride scholarship, the 529 might not be used. Unless transferred to another beneficiary, the funds can’t be withdrawn without being taxed, plus an additional 10% penalty. Fortunately, the penalty may be waived if the student receives a scholarship. What’s more, up to $10,000 of the 529 can be used for K-12 education, and up to $10,000 can be used for student loan repayment.

Of course, some people prefer to save for education in a separate brokerage account rather than a 529 plan. These savings don’t come with tax benefits, but they can be used for anything, not just education. Again, some people opt for flexibility over potential tax savings.

Additionally, the Consolidated Appropriations Act of 2023 has had a significant influence on SECURE 2.0, introducing a provision that allows 529 plans to be rolled into Roth IRAs. This gives another option for potentially unused 529 assets, especially for parents who had saved for education at the expense of saving for their own retirement. There are a lot of stipulations to consider before taking advantage of this option, so it is essential to seek advice from your financial advisor before proceeding.

The Bottom line

Ultimately, there are pros and cons of 529 plans for grandparents and parents to consider. These plans can be beneficial tools for parents and grandparents who want to save money on higher education. The federal tax benefits of 529 plans and the option to roll over into Roth IRAs make the potential growth of funds significant. Along with considering other financing options, such as separate brokerage accounts, parents and grandparents should research their state’s 529 plans and consider all their options to determine which form of planning best suits their families’ needs.


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