Grandparents are increasingly using 529 College Savings Plans and other means to help defray the costs of rising college tuition and leaner parental savings.
A four-year public, out-of-state college education now averages roughly $100,000 in tuition and other expenses, according to the College Board, leaving multiple generations to help shoulder the bill. For many families, grandma and grandpa are helping to pay for college, and are turning to tax-advantaged 529 College Savings Plans.
Parents on average put aside roughly 10% of their total savings for their kids’ college education, a target that hasn’t changed much in recent years. But the average amount earmarked for higher ed dropped to $10,040 in 2015, according to the Sallie Mae How America Saves For College 2015 study.
A higher cost of living and unexpected expenses were common factors cited for the decline, which marked the lowest level since Sallie Mae first conducted the study in 2009. With expenses only climbing, help from grandparents is likely to keep growing in importance.
Tax-advantaged 529s require no minimum contributions, and grandparents can fund up to $14,000 per year per child, or up to $70,000 total in a single year, without incurring federal gift taxes. Keep in mind that this assumes no other taxable gifts have been made in the same year and that the contribution does not exceed eligible education expenses.
A 529 College Savings Plan offers the ability to grow assets in a tax-deferred account, and withdrawals for qualified higher education expenses remain free of federal taxes. Assets in a 529 plan may be excluded from your taxable estate as well. But, the earnings portion (if any) of a Non-Qualified Withdrawal will be treated as ordinary income to the recipient, and may be subject to an additional 10% federal tax penalty.
It’s important for families to factor in any potential financial aid impact. A 529 account held by a grandparent plays into the financial aid calculation differently from an account held by a parent.
In the case of a parent-held 529 account, the college savings plan is considered to be a parental asset and is included in the Expected Family Contribution (EFC) calculation for federal financial aid. But the assets in a 529 account in a grandparent’s name are not counted as a portion of the EFC formula. Instead, once the assets are distributed, they are counted as student income, which can have its own impact on financial aid. Any student income above $6,130 could have repercussions for student financial aid eligibility.
The financial aid formulas favor saving money in a parent’s name over the child’s name. Parental assets are assessed at up to a 5.6% rate, while a child’s assets are assessed at a 20% rate, according to the Federal Student Aid division of the Department of Education.
If the compromise to financial aid is a worry, there are options grandparents can consider.
First, grandparents could contribute to an existing parental 529 account. Or, the grandparent could change their account ownership name to the parents.
Another strategy includes a student delaying utilizing distributions from the grandparent 529 plan until their senior year, as it would no longer impact future financial aid awards.
Another option for grandparents is to pay colleges directly, but that has financial aid implications as well.
“If the grandparent funds the college directly, that’s considered a resource to the college and the college can then reduce any need-based grants dollar for dollar,” says Dan Maga II, vice president at American College Funding, a college financial planning firm.
Bottom line: communication can go a long way to bolster savings efforts between generations, and a financial planner can help with college-savings goals.