529 plan basics

REGION – Section 529 plans are governed by federal law but are sponsored by states and colleges. Each plan may have slightly different features, but each must conform to the federal framework. There are two types of 529 plans – college savings plans and prepaid tuition plans.

Learn how a 529 plan can help you save for your child or grandchild’s college education. Stock photo.

Each type of 529 plan has an account owner, or the person who opens the account, and a beneficiary, the person for whom contributions are being made. The account owner has the flexibility to make contributions to the account, request withdrawals from the account, change the investment selections for the account, and change the beneficiary of the account.

Grandparents can open a 529 account and name their grandchild as beneficiary, or they can contribute to an already established 529 account.

College savings plans

College savings plans are the more popular type; nearly all states offer one or more of these plans. A college savings plan functions like an individual investment-type account. You select one or more of a plan’s investment portfolios, and you either gain or lose money, depending on how those portfolios perform. College savings plans typically accept over $300,000 in maximum lifetime contributions, and these funds can be used for tuition, fees, room and board, books, and equipment at any accredited college in the United States or abroad. However, each plan has its own rules and restrictions, which can change at any time.

Prepaid tuition plans

By contrast, a prepaid tuition plan pools your contributions with the contributions of others, and in return you get a predetermined number of units or credits that are guaranteed to be worth a certain percentage of college tuition in the future. Funds in a prepaid tuition plan can only be used to cover tuition and fees at the limited group of colleges that participate in the plan. Prepaid tuition plans are generally limited to state residents, whereas college savings plans are open to residents of any state.

Grandparent as account owner

A grandparent isn’t required to be the account owner of his or her grandchild’s 529 plan to make contributions to the account. But if the grandparent is the account owner, there are some additional considerations.

First, as account owner, a grandparent can retain some measure of control over his or her contributions by changing investment selections, authorizing account withdrawals for both education and non-education purposes, or even closing the account. A grandparent will have this control over these contributions even though they generally aren’t considered part of his or her estate for tax purposes – a rare advantage in the estate-planning world. However, funds in a grandparent-owned 529 plan can still be factored in when determining Medicaid eligibility, unless these funds are specifically exempted by state law.

Second, regarding financial aid, a grandparent-owned 529 account does not need to be listed as an asset on the federal government’s aid application, the FAFSA. However, distributions  from a grandparent-owned 529 plan are reported as untaxed income to the beneficiary, and this income is assessed at 50 percent by the FAFSA. By contrast, a parent-owned 529 plan is reported as a parent asset on the FAFSA, but distributions from a parent-owned 529 plan aren’t counted as student income.

To avoid having a distribution from a grandparent-owned 529 account count as student income, one option is for the grandparent to delay taking a distribution from the 529 plan until anytime after Jan. 1 of the grandchild’s junior year of college because there will be no more FAFSAs to fill out. Another option is for the grandparent to change the owner of the 529 plan account to the parent.

Colleges have their own rules when distributing their own financial aid. Most colleges require a student to list any 529 plan for which he or she is the named beneficiary, so grandparent-owned 529 accounts would be treated the same as parent-owned accounts.

Written by Huntley Financial Services. For more information, call Mark Huntley at 888-922-1035.

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