College-Savings Plan Change May Spur Grandparents' Giving

Giving your grandchild a new toy or game or clothes is nice. But helping pay for their future college education? Now, that's a gift your grandkid and their parent — your adult child — will never forget.

One smart way to do it: Opening and funding a 529 college savings plan. These are state-sponsored investment accounts that enable you to save money tax-free to pay for some or all of the college costs for a child, grandchild or other beneficiary. A new federal rule taking effect next year will make doing so even better.

Helping your beneficiary foot that college bill and avoid student loans (current interest rate: roughly 5.5% to 8.0%) can be a huge money saver for them and their parents.

The average annual cost of attending a private, four-year college now tops $53,000; it's a tad over $23,000 for an in-state public institution, according to The College Board. The average federal student loan debt: $37,787. (The Supreme Court recently struck down President Joe Biden's plan to cancel $10,000 to $20,000 in federal student loan balances for more than 40 million borrowers.)

Many state-run 529 plans let you open accounts with as little as $500 or $1,000. When you fund your grandkid's college costs with one, the money you contribute grows tax free and can be used for any college in any state. Distributions from the plan for education expenses are tax free, too.

If your beneficiary winds up not going to college or receives a full scholarship, you can change the 529 beneficiary to another grandchild or family member. Or you can withdraw the contribution amounts from your grandparent-owned 529 tax-free and penalty-free (you will owe taxes and a 10% penalty on the earnings, though).

Money in a 529 plan can help pay tuition, on- and off-campus housing, food and meal plans, books and supplies, computers and software, internet service and even up to $10,000 in student loan repayments for the beneficiary and their siblings.

You can contribute up to $17,000 in 2023 without incurring a gift tax (married couples can contribute as much as $34,000). But there's also a tax technique known as "5-year gift tax averaging" or superfunding that lets you contribute up to $85,000 to a 529 this year if you treat it like you spread the money over five years.

Most states have annual lifetime contribution limits of $235,000 to $550,000 for their 529 plans. Two-thirds of states let you claim an income-tax deduction or credit based on your 529 contributions; the write-off is determined by the state you live in, not where the college is.

If you funded a 529 plan for your child who didn't need all the money in it (as happened to me), you may be able to transfer the remaining balance into a 529 for your grandchild without any tax consequences. Check with your 529 plan's management company.

Speaking on the latest episode of the "Friends Talk Money" podcast I co-host with Terry Savage and Pam Krueger, college financing expert Mark Kantrowitz said grandparents can open 529 plans in one of three ways.

"One is where the parent is the account owner. Another is where the student is both the beneficiary and the account owner; it's called a custodial 529 plan account and the grandparent could be the custodian. And finally, the grandparent could be the account owner and the grandchild would be the beneficiary," said Kantrowitz, author of five bestselling books on financial aid and scholarships.

A key benefit of grandparents owning the 529: Starting with the 2024–2025 college year, "a grandparent's distribution is not reported as an asset on the federal student aid form, or FAFSA," said Kantrowitz.

By contrast, the value of a 529 owned by a student or parent is considered a parent asset on the FAFSA and some of that money could reduce the student's financial aid package by up to 5.64%.

When deciding on a 529 plan for your grandchild, you'll want to compare fees, investment choices and tax benefits. The Saving for College site offers a handy 529 comparison tool, letting you see more than 40 features of 529 plans across the country.

According to Kantrowitz, the entire process of choosing and setting up a grandparent 529 should take less than a half hour.

Plans opened directly with state agencies generally are less expensive than those opened through an advisor, who can charge commissions of 5% or more — in additional to the 529's annual fees.

On the podcast, Savage said, you can keep 529 investing decisions simple by going with an "age-based plan," where the plan's manager adjusts holdings as your grandchild gets older.

Here, when the child is a baby or toddler, the plan is weighted heavily toward stocks. That's because the stock market has historically offered the best long-term returns. As the child gets older, the 529 will increasingly tilt toward less-volatile investments such as bank CDs and money-market accounts.

Alternatively, you could put some money in an S&P 500 index fund and some in its low-risk options and then adjust those holdings over time to make the account increasingly more conservative and safer.

"You don't need to have a ton of investment options," Kantrowitz noted.

For more information about 529 plans and college financing, check out these sites: the U.S. Department of Education's Studentaid.gov, Savingforcollege.com, The College Board's Collegeboard.org and Fastweb.com.

One final tip from Kantrowitz: The sooner you start funding your grandchild's 529 plan, the easier it will be for you to help with the tuition expenses.

"If you start saving at birth, about a third of your college-savings goal will come from the earnings. If you wait until the grandchild enters high school, less than 10% will come from the earnings and you'll need to save about six times as much per month to reach the same goal," he said.

You can invest in a 529 for your grandchild without having to remember to do it by setting up an automatic investment plan that transfers a set amount of money each month from your bank account to the college savings plan.

Richard Eisenberg is the former Senior Web Editor of the Money & Security and Work & Purpose channels of Next Avenue and former Managing Editor for the site. He is the author of "How to Avoid a Mid-Life Financial Crisis" and has been a personal finance editor at Money, Yahoo, Good Housekeeping, and CBS MoneyWatch. Read More