5 financial tips for grandparents using a 529 plan to save for college

A 529 plan is a savings account that can help cover qualifying education expenses. These plans have many advantages, such as portability and favorable tax treatment. A 529 plan allows family members such as parents and grandparents to help contribute to a child’s education.

The average annual in-state tuition cost at a four-year college is $9,678, according to the Education Data Initiative, while out-of-state tuition averages $27,091. Additional costs for things such as books, supplies and food average about $16,000-17,000 per year. With college costs high and only increasing, a 529 plan is more essential than ever.

Here’s how grandparents can use a 529 plan to help grandchildren with education expenses.

Key student debt statistics

What is a 529 plan and how does it work?

A 529 plan is a tax-advantaged account that helps cover the cost of college and other education expenses. The account allows contributors to deposit after-tax money, put it in potentially high-return investments, and withdraw it tax-free if it’s used for qualified education expenses. Plus, some states offer tax deductions for those who contribute to the plans.

Those qualified education expenses can include tuition, room and board, and even student loan balances, following changes to the plan, as well as for K-12 tuition at private schools.

Parents with young children are typically the ones who open a 529 plan. But grandparents, other relatives, or even friends can open one, too. The student who will ultimately use the savings plan can also open one on their own behalf. A 529 plan has no annual contribution limit.

Sometimes college plans change, but fortunately you can change the plan’s beneficiary, use plan money to help pay down student loans, or, starting in 2024, roll unused 529 plan money into a Roth IRA for the plan’s beneficiary. If the money can’t be used or rolled into a Roth IRA, it can be withdrawn, but you’ll likely pay a 10 percent penalty and have to pay taxes on the earnings.

1. Determine account ownership

If you are a grandparent who would like to open a 529 plan to contribute to your grandchild’s college fund, you’ll encounter the question of ownership. For instance, should you be the owner, or should the student? Or perhaps one or both of the student’s parents should take ownership?

If the student is a minor when the account is opened, you or the child’s parent(s) will likely be the account owner, at least until the child reaches the age of majority. Whether it makes more sense for you or the student’s parents to be the account owner will vary case by case. For example, you can give the parents ownership if you don’t feel confident in managing money and investments. There also may be financial aid implications to consider.

You can also transfer the account just once a year, unless a change in beneficiary is involved. Plans can be transferred to a variety of family members or their spouses.

2. Be aware of financial aid implications

One of the most significant caveats to 529 plans has been their impact on a student qualifying for financial aid. If the student received money to pay for college before the final two years of attendance, that money was considered income for the student. That could make it more difficult for them to qualify for financial aid.

These concerns should be eased by the passing of the FAFSA Simplification Act, set to go into effect for the 2024-2025 academic year. When the new rule goes into effect, grandparents who contribute to 529 plans will no longer hurt their grandchildren’s ability to qualify for financial aid. This is because the new FAFSA will no longer ask about outside contributions to 529 plans.

And because of the delayed timing on reporting for the FAFSA forms, grandparents can now start taking advantage of a 529 plan without fear that it hurts their relative’s other aid chances.

3. Take advantage of the gift tax exemption

A 529 plan does not set a limit on how much any one person can contribute to the plan in a given year. However, money that a grandparent contributes is considered a gift, meaning gift taxes can apply. Fortunately, you can contribute up to $17,000 per year per donee in 2023 as an individual without being subject to gift taxes, or $34,000 per couple.

It is also possible in some cases to make up to five years’ worth of contributions at once without incurring a gift tax, in a process called frontloading or superfunding. That means a wealthy couple can potentially contribute as much as $170,000 in 2023 per donee free of gift tax, but could not contribute again for five years without incurring the gift tax.

4. Use a 529 to repay student loans

The Setting Every Community Up for Retirement Enhancement (SECURE) Act of 2019 added a provision that allows people to use 529 plans to repay up to $10,000 in student loans for the direct beneficiary of the plan. Plus, a further $10,000 can be used for any of the beneficiary’s siblings. Payments may include both principal and interest on any qualifying education loans. The beneficiary can also be changed to pay for another grandchild’s loans, if desired.

The act also allows 529 plans to cover certain apprenticeship program expenses.

Pros and cons of using a 529 plans to pay off student loans

5. Consider alternatives

A 529 plan offers tax advantages, portability and control. However, it may have limited investment options, and its potential impact on financial aid could make alternatives worthy of your consideration.

For example, custodial accounts such as UGMA/UTMA accounts have more flexibility in their investment choices while still having no cap on contributions. However, custodial accounts have their own drawbacks, such as less favorable tax treatment compared to 529 plans. They also give control to beneficiaries as soon as they reach the age of majority (usually 18 or 21), which could be a problem if they are not particularly interested in higher education.

Another possibility is the Coverdell education savings account (ESA). One benefit of Coverdell ESAs is they can cover not only college expenses but also primary and secondary education expenses. Plus, earnings and withdrawals can be tax-free if they cover qualifying education expenses, and investment options are broader than for 529s. But contributions are limited to $2,000 per year, and the beneficiary must be under the age of 18 when the account is opened.

Of course, you can also pay for school as you go, using general funds. This approach gives you maximum flexibility for the money, but doesn’t come with the tax benefits of 529 plans.

529 plan overview

A 529 plan gives both parents and grandparents the option to contribute to a child’s education fund. They have no annual contribution limit and an individual can contribute up to $17,000 per year while avoiding gift tax rules, or $34,000 per couple. A 529 withdrawal is generally free of federal taxes if used to cover qualifying education expenses — and is often free of state taxes, too.

However, 529 plans do have their drawbacks, such as limited investment options, though if you search for the best 529 plans you can find good options. Other types of accounts, such as UTMA/UGMA and Coverdell ESAs can help with these drawbacks, although they have their own downsides. Be sure to weigh all the options before deciding which kind of account to open.