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Source: The College Investor
What is a grandparent-owned 529 college savings plan? How does it work? What do you need to know about it, and what changes should you be aware of?
A grandparent-owned 529 plan is a type of 529 college savings plan where the account holder is a grandparent rather than a parent, and the beneficiary is the grandchild.
Another alternative would be a 529 custodial plan account where the grandchild is both the account holder and beneficiary, but the grandparent acts as custodian. There is no restriction on the type of 529 plan grandparents can contribute to. Grandparents can contribute to grandparent-owned 529 plans, 529 custodial plans, and parent-owned 529 plans.
Keep in mind that grandparent-owned 529 plans impact eligibility for need-based financial aid differently than parent-owned 529 plans. Here's what you need to know if you're interested in a grandparent-owned 520 plan.
What you should know as an account holder
If you are a grandparent, there are several reasons why you may or may not want to be an account holder. The main factors for account ownership are tax implications, financial support, and estate planning.
- You have control over the funds: By serving as the account holder and not contributing to a parent's 529 plan, the grandparent maintains control of the account, which may be necessary to ensure the money is spent for the benefit of the grandchild if the parents are spendthrift.
- You can access the resources when needed: You can withdraw the money from a 529 plan account as a non-qualified distribution if needed.
- Tax benefits: To claim a state income tax credit, you may need to be the account holder.
- To open an account, you don’t need much information: The grandparents can keep the plan secret from the parents and grandchildren to surprise the family when they announce that they have been saving for the grandchild's college education. All you need to know is the grandchild's date of birth and social security number to open the account.
The impact on your taxes
Two-thirds of states offer an income tax deduction or tax credit based on contributions to the state's 529 plan. In the following 10 states, the taxpayer must be the account holder (or the account holder's spouse) to qualify for a state income tax reduction.
Search for your state in our 529 plan guide and see what tax deductions or credits are available to you >>
529 plans offer significant advantages in estate planning
Contributions to a 529 plan are immediately removed from the contributor's estate pending the annual gift tax exemption, even if the contributor retains control of the 529 plan as account holder.
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How much you can give away tax-free each year |
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Under five-year gift tax averaging (also called superfunding), contributors can donate a lump sum of up to five times the annual gift tax exemption amount and have it treated as if it had spanned a five-year period.
For example, you can donate up to $90,000 (5 x $18,000) per beneficiary, or you and your spouse can donate up to $180,000 per beneficiary.
Each year, a portion of the gift is taken from your estate. If you give a lump sum, the beneficiary can invest the entire amount immediately, rather than just a fifth of the amount each year.
For more information on 529 plan contribution limits, click here.
Income is accumulated tax-free
Qualified distributions are completely tax-free. Qualified distributions include amounts spent on college expenses, such as:
Qualified distributions can also be used to pay elementary and secondary school tuition fees up to $10,000 per year.
Qualified withdrawals can also be made to pay off up to $10,000 of the beneficiary's student loans and $10,000 for each of the beneficiary's sibling. (If the beneficiary changes, the 529 plan can also be used to pay off up to $10,000 of parent loans.) The $10,000 limit is a lifetime limit per borrower, regardless of the number of 529 plans.
The earnings portion of a non-qualified distribution is subject to the recipient's tax rate plus a 10% tax penalty. The recipient can be the beneficiary or the account owner. Here are some common expenses that are non-qualified distributions:
The tax penalty is waived if the recipient is deceased or disabled or
- A tax-free grant or scholarship such as the American Opportunity Tax Credit (AOTC) or the Lifetime Learning Tax Credit (LLTC)
- Attended a US military academy
- Educational assistance for veterans
- Training support paid by the employer up to the amount of the training allowance
Taxes on intergenerational transfers
When grandparents contribute to a 529 plan for a grandchild, they may be subject to the generation-skipping transfer tax (GST).
GST is payable if the beneficiary is 37.5 years younger than the donor. However, GST is not payable if the grandchild's parents are both deceased. GST is subject to the same exclusions and exemptions as gift taxes. In particular, the $18,000 annual gift tax exemption and the 5-year gift tax averaging calculation apply.
If you choose to give more, use up part of your lifetime exemption amount, which was $13.6 million in 2024 ($27.2 million for a couple).
Most people don't have to pay GST or gift tax, but if you gift more than $18,000 to a beneficiary in a single year, you must file a U.S. gift (and generation-skipping transfer) tax return, IRS Form 709.
Impact on financial assistance
The financial aid implications depend on who owns the account. This affects how the 529 is reported as an asset on the Free Application for Federal Student Aid (FAFSA) and how withdrawals are reported as income on the FAFSA. The table below tells you who owns the account, how they are reported on the FAFSA, and how qualified withdrawals are counted.
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How it is reported on FAFSA |
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Parents of the dependent student |
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All others: grandparents, aunt, uncle, non-custodial parent |
Not reported as an asset |
In all cases, the income portion of a nonqualified distribution is included in the adjusted gross income (AGI) on the recipient's federal income tax return. Therefore, it is reported as income on the following year's FAFSA.
How the 529 plan and distributions on FAFSA affect the student's eligibility for need-based financial aid
Parental assets reduce eligibility for need-based financial aid by up to 5.64%. Student assets reduce eligibility for need-based financial aid by up to 3.29% if the student has dependents other than their spouse. Assets are reduced by 20% if the student has no dependents other than their spouse.
QQualified withdrawals from a grandparent-owned 529 plan no longer affect eligibility for need-based financial aid. The same is true for a 529 plan owned by someone else.
This means that 529 plans owned by grandparents are not reported as an asset and qualified distributions are not reported as income on the FAFSA application. (Non-qualified distributions are still counted as income.) The FAFSA simplification eliminates the cash assistance question, which previously reported untaxed student income.
Examples
For example, if there is a $10,000 balance in a 529 plan of a dependent student or the dependent student's parents, the student's eligibility is reduced by up to $564.
If the 529 plan is owned by an independent student, eligibility is reduced by up to $2,000.
If the 529 plan is owned by a grandparent, there is no reduction in support eligibility.
Want to learn more about 529 plans? Check out our ultimate guide.
For more information about 529 plans, see IRS Publication 970.
The legal provisions regarding the tax treatment of 529 plans can be found in the Internal Revenue Code of 1986 under 26 USC 529.
The legal provisions for financial support of 529 plans are found in the Higher Education Act of 1965 at 20 USC 1087vv(a)(B)(2) and (f)(3).
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