Insights & News

August 2015
Tax Planning

The Grandparent "Gotcha" in 529 College Savings Plans!



By: Mark Stinson, Senior Advisor

Retirees Early and Happy are overjoyed at the birth of a new granddaughter. Their daughter, Faith, gave birth to Grace on Father’s day – a bit of serendipity Happy points out to anyone that will listen. Daughter Faith had an uncomfortable family vacation at Ocean City, MD. Now she is a joyous, if somewhat tired, new Mom.

Of course Grandmom Happy, ever diligent, called me the next day to spread the news and to inquire about setting up a college fund. And, of course, Early asked about a tax deduction.

529 plans are, in most cases, the college savings plan of choice (check with your friendly financial advisor about your situation). Early was elated to know, as a Maryland resident, he can claim a tax deduction of up to $2,500 on his Maryland income tax return if Happy opened a 529 in the Maryland Plan.

Setting up a 529 for a grandchild is much like setting up one for a child, with one major difference. Funds used from Happy’s (Grandmom’s) 529 to pay for Grace’s (grandchild’s) college affect Grace’s eligibility for financial aid in a much harsher way than withdrawals from Faith’s (Mom’s) 529.

Merely opening a 529 for a grandchild does not affect the grandchild’s eligibility for financial aid because a 529 owned by a grandparent is not reportable on the Federal Application for Student Financial Aid (FAFSA). However, withdrawals from the grandparent’s account to pay for college is treated as untaxed income to the grandchild.

This income must be reported on the FAFSA application the year following withdrawal and may reduce the child’s aid package by up to 50% of the withdrawal amount. This is almost 10 times harsher than withdrawal from the parent’s account. The reason: withdrawals from the grandparent’s account are considered income to the child, while withdrawals from the parent’s account are not.

Still, Happy should open a 529 because:

  • Early gets a tax deduction and can crow about it among his bicycling buddies! Grace may not be eligible for financial aid due to Faith’s family income and assets.

  • The 529 can be used to pay for the last year of college and Grace will not be completing a FAFSA the next year.

  • Happy can transfer the account to Faith before Grace enters college. Maryland allows this transfer of ownership, not all states do. Check with your friendly advisor.

  • If you are a member of the “sandwich generation” and have questions about setting up college funds for grandchildren, elderly parents, financial planning, or investment management contact Mark Stinson at mstinson@investfai.com or 410-715-9200.

IMPORTANT DISCLOSURE INFORMATION
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