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Should Grandma and Grandpa Help Save for their Grandchild's Education?

| March 16, 2016
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529 College Plans

When I was a child and teenager, my grandparents would slip some dollar bills into each birthday card they sent to me.  I would transfer the bills into my piggy bank or wallet and spend it in my next purchase without much thought.  Much of the time that purchase would go towards a video game, soda, or a burger at a local fast food restaurant.  Is that what my Grandma or Grandpa would have wanted?  Is there a better way to give grandchildren gifts that they can appreciate and truly thank us for receiving?

Consider this idea.  Open a 529 college savings account with the help of your financial advisor in the name of the grandchild. Set up a periodic contribution plan to systematically contribute a set amount to the plan over a long period of time.  Even small amounts can make a big difference for the grandchild over time.  I’ll give you an example:  Let’s assume a 6% annual return of your investments and you contribute $20 on a monthly basis soon after the grandchild is born.  By the time he/she turns 18, the total value you would have contributed, $4,320, would have grown to $7,747.06!  Obviously this calculation is based off assumptions and not actual market conditions, but you get my point. That growth is tax-deferred during those years and tax-free at withdrawal as long as it is used towards qualified education expenses.  If you want to go the extra mile, in 2016 you could contribute a total of $28,000 a year between you and your spouse during the year (subject to gifting limits).

Why Is This So Great?

More and more parents are having difficulty in savings for their child’s education at a young age.  I have seen multiple occasions where parents have come into our offices asking how best to save for their 16 year old child’s college education.  By then it is TOO LATE!  The big benefit in compound interest comes with time.  The earlier you start, the greater the benefit could be.  If the grandparents are able to save in the way I mentioned above, this could either assist or completely pay for the grandchild’s last year of college tuition, or more.  This could take much of the financial burden off the shoulders of both parent and child.

The Little-Known Rule

One rule that is not often discussed when considering a 529 plan is the inherit benefit of a grandparent owning the 529 plan instead of the parent.  When the child applies for FAFSA (federal student aid), a  529 owned by a parent for the benefit of the child, is counted as an asset and included in the complex calculation of possible benefits as long as the child is a dependent.  This could mean less money for the child in the form of a grant.  If the 529 account is owned by the grandparent, the assets are now not included on the grandchild’s application and the grandchild could qualify for a larger grant. 

There is a downside.  As soon as the 529 plan owned by the grandparent starts distributing, it must then be reported on the grandchild's FAFSA and it hurts them even more than if their parents owned them.  The trick is to use the grandparent's 529 plan to fund the child's last 1 or 2 years of school, so that there are no more FAFSA applications in the following years to report the funds that were spent from the grandparent's 529 plan.

This extra grant money combined with the 529 savings by the grandparent can have monumental benefits for the grandchild.  This not only could help in their college education, but teach them valuable lessons about saving, compound interest, and investing.  These lessons and the money received can leave a long lasting impression upon your grandchild and for their future kids.  I would imagine they would thank you more for these lessons and the help they received, than for a quick burger at a fast food restaurant.  But as with most good things, the appreciation will come with time.

Disclosure: Prior to investing in a 529 Plan investors should consider whether the investor’s or designated beneficiary’s home state offers any state tax or other benefits that are only available for investments in such state’s qualified tuition program.  Withdrawls used for qualified expenses are federally tax free.  Tax treatment at the state level may vary.  Please consult with your tax advisor before investing.  Non-qualified withdrawls may result in federal income tax and a 10 percent federal tax penalty on earnings.

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