Editor’s note: Read part one, Paying for College: Should You Dip Into Your Roth IRA?
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.
Why the Need?
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.
How Does it Work?
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.
Financial Aid Impact?
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.
There Are Options
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.
What about Direct Payment?
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.
529s: You Have Choices
The TD Ameritrade 529 College Savings Plan offers four age-based investment options, three static investment options, and 17 individual investment options.
The TD Ameritrade 529 College Savings Plan (the "Plan") is sponsored by the State of Nebraska and administered by the Nebraska State Treasurer. The Plan offers a series of investment portfolios within the Nebraska Educational Savings Plan Trust (the "Trust"), which offers other investment portfolios not affiliated with the Plan. Nebraska Educational Savings Plan Trust serves as Issuer. The Plan is intended to operate as a qualified tuition program to be used only to save for qualified higher education expenses, pursuant to Section 529 of the U.S. Internal Revenue Code.
An investor should consider the Plan’s investment objectives, risks, charges and expenses before investing. The Program Disclosure Statement for the Plan at collegesavings.tdameritrade.com, which contains more information, should be read carefully before investing.
Investors should consider before investing whether their or their beneficiary’s home state offers any state tax or other benefits that are only available for investments in such state’s qualified tuition program and should consult their tax advisor, attorney and/or other advisor regarding their specific legal, investment or tax situation.