The Joseph Group

Understand 529 Plan Ownership to Maximize Impact

August 27, 2020

To Inform:

I recently had a client ask me about the best way to save for college for their grandchildren. Immediately the 529 plan comes to mind but it’s not just that simple. Let’s start with the basics of a 529. Investment earnings and withdrawals are tax-free as long as they are used for qualified educational expenses. In addition to college, trade or technical school, those qualified expenses also now include elementary, middle school and high school expenses. Recently, with the passing of the SECURE Act in early 2020, parents and grandparents now have the ability to use 529 distributions to pay back student loans as well as to pay for textbooks, fees and equipment related to apprenticeship programs.

When it comes to using a 529 for post-secondary expenses there are some things to consider. In order to apply for need-based financial aid, a student must complete the Free Application for Federal Student Aid (FAFSA) which looks at the income and assets for parents and students. This is where ownership of the 529 can become a very important variable. A parent-owned 529 reduces eligibility for need-based financial aid only up to 5.64% of the asset value, whereas a student-owned 529 can reduce eligibility by as much as 20% of the asset value. A 529 owned by a grandparent (or aunt, uncle, cousin or non-custodial parent), however, does not get reported on the FAFSA, so it may appear that this is the better option. Be careful, because once money is withdrawn from the grandparent-owned 529 and used to pay for college expenses, it’s considered income to the student and it has to be reported on the FAFSA. Once income is reported on the FAFSA, up to 50% of that student’s income is considered available to pay for college, so money used from a grandparent’s 529 can adversely affect a student’s financial aid by as much as 50% of the distribution amount in future years!

So, what can we do instead? Grandparents, aunts, uncles, friends, etc. can contribute directly to the parent-owned 529. Grandparents who wish to get any state tax deductions can contribute to their grandparent-owned 529 and then may consider transferring ownership to the parent when it is time to use the account (check with the company managing the 529 to be sure there are not tax consequences in doing so). Or, simply use the grandparent-owned 529 last. Since the FAFSA uses tax information from two years prior, use the grandparent-owned 529 for the last 2 years of college expenses, then the distributions will not show up as income on the FAFSA for the student.

Other considerations:

  • In a grandparent-owned 529 it is wise to name a successor owner.
  • Assets in a 529 owned by a grandparent are considered the grandparent’s assets for Medicaid means testing purposes. Any 529 account balance would need to be spent before Medicaid payments could begin.
  • Any withdrawals taken from a 529 that are not used for qualified education expenses are subject to income tax and a 10% penalty on the earnings.
  • If the beneficiary student decides to enter the military, distributions are free of the 10% penalty, but you must pay income tax on the earnings.
  • If the beneficiary student receives a scholarship, you may withdraw that exact amount from a 529 plan and use it for anything free of the 10% penalty, but you must pay income tax on the earnings.

Since much of the need-based aid is in the form of loans, most students do not get enough in scholarships for a full ride to college so saving in a 529 is a great way to fill that gap, just be sure to think about ownership and withdrawal strategies.

We love to help our clients think about planning for specific goals and how to go about accomplishing those goals. If you have questions about how to establish, fund or utilize a 529 plan please contact your Joseph Group advisor or give me a call.




This WealthNotes Inform was written by Dave Suchland, Client Advisor & Team Leader