The cycle continues: Your adult children — one of the first generations to benefit from Section 529 plans — are saving for their kids’ college educations through 529 accounts of their own. Did you know that parents aren’t the only ones who can establish 529 plan accounts? As a grandparent, you can follow the same path. In fact, recent enhancements may encourage you to include 529 plans in your estate plan.
Types of plans
There are two types of 529 plans: prepaid tuition plans and college savings plans. A prepaid tuition plan is designed to keep pace with rising tuition costs. Essentially, you buy shares at a current price that can be used to pay for tuition in the future. This plan is attractive because there’s no risk of loss of principal and the investment may be guaranteed by the state.
With a college savings plan, you can’t lock in future tuition expenses as you can with a prepaid tuition plan. But it has a bigger potential upside because you may be able to generate a better return.
Typically, the plan will offer an asset allocation strategy based on your grandchild’s age. For example, it may provide aggressive investments in the early years and then switch to more conservative investments. Most college savings plans also offer a wide range of risk-based asset allocation portfolios managed by professionals.
Each state sets its own limits on contribution amounts to its college savings plan. But most limits are generous and reach well into six figures. Check the rules for the states you’re considering.
Depending on your situation, you might set up accounts for several grandchildren. After one grandchild graduates, you can roll over any remaining funds into the account of a younger grandchild. Similarly, you may transfer funds if a grandchild decides not to go to college or drops out.
Tax implications
529 plans offer tax benefits on both the federal and state levels. First, the amounts you contribute to the account can continue to grow tax-free. There are no potential tax consequences until amounts are withdrawn.
Second, no tax is imposed on withdrawals used to pay for qualified higher education expenses. Typically, these include tuition, fees, books, supplies and equipment, plus room and board for students who are enrolled at least half-time. Distributions for other reasons, however, are taxable.
Third, many states offer tax breaks for contributions, including deductions or matching grants, subject to certain restrictions.
What about gift tax? Contributions to a 529 plan may be sheltered by the annual gift tax exclusion. For 2024, the exclusion is $18,000 per recipient ($36,000 for joint gifts by a married couple). Any excess is sheltered by the federal gift and estate tax exemption ($13.61 million in 2024).
Unique opportunity: The tax law allows you to give up to five years of contributions to a 529 plan at one time that’s sheltered by the annual gift tax exclusion. For instance, you and your spouse can contribute a total of up to $180,000 per recipient in 2024 — all of it exempt from gift tax.
Recent enhancements
The favorable tax rules for 529 plans have been further enhanced by recent developments. Prior to the Tax Cuts and Jobs Act (TCJA), the tax exclusion for qualified expenses was strictly limited to colleges and graduate schools. Under the TCJA, this tax break is extended to the first $10,000 of tuition at an elementary or secondary public, private or religious school.
Also, the SECURE Act allows you to use up to $10,000 in a 529 plan to repay the beneficiary’s student loans, plus another $10,000 to repay student loans held by the beneficiary’s siblings. It also allows 529 funds to be used to pay for apprenticeships (for example, classroom instruction at a community college).
Finally, a change in the way that financial aid is calculated on the Free Application for Federal Student Aid (FAFSA) form may help grandchildren. Gifts from grandparents to 529 accounts no longer affect the allowable aid.
Give to future generations
Given the high costs of a college education, as well as many private elementary and secondary schools, it’s important to plan for these expenses. Opening 529 plans for your grandchildren can be a powerful, tax-efficient tool you can use to save for their education expenses. And the estate planning benefits are a plus. Consult with your estate planning advisor to learn how 529 plan accounts may affect your plan.
