Latest / The College Savings Podcast with Fexingo: 529 Plans, Education Funding, and Student Costs / 529 Plan Tax Strategies for Grandparents
Transcript
- Lucas: So Luna, we've done a lot of episodes on what a 529 can pay for, but today I want to talk about who's actually putting the money in. Specifically, grandparents. Luna: Oh, that's a good one. Grandparents are often the ones asking me, 'Can I contribute without messing up financial aid?' And the answer is, well, it depends. Lucas: Right. And before we get into the weeds, I want to mention something we've been meaning to say. You know, we keep this show intentionally ad-free, and that's a choice we make because we think it keeps the advice cleaner. If you want to support that, there's a link on our site, buy me a coffee dot com slash fexingo. No pressure, but it helps us keep doing this. Luna: Yeah, we really appreciate the listeners who've done that. It lets us focus on the substance. Lucas: Exactly. So let's get into the gift tax. The basic rule is that anyone can contribute up to eighteen thousand dollars a year to a 529 for someone else without triggering a gift tax return. That's the annual exclusion for 2026, indexed for inflation. Luna: So a grandparent can give eighteen thousand to each grandchild, and that's totally clean? Lucas: Clean as can be. But here's where it gets interesting. The IRS allows a special election, sometimes called 'superfunding,' where you can contribute up to five years' worth of gifts in one year, so ninety thousand dollars per grandchild, and just check a box on Form 709 to spread it over five years. That's a powerful way for a grandparent to move a chunk of money out of their estate. Luna: And that's great for estate planning, but what about the financial aid angle? Because I think that's the part that trips people up. Lucas: Right. So here's the classic problem. A grandparent-owned 529 is not reported as an asset on the FAFSA, which is good, but when you take a distribution from it to pay for college, that distribution is counted as untaxed income to the student. And income counts heavily against you in the aid formula. Luna: So it can tank the next year's aid package. I've seen families get burned by that. Lucas: Exactly. But there's a workaround that's become more popular since the FAFSA simplification went into effect, and that's to list the beneficiary as a sibling, not the student. If the grandparent owns a 529 with the student's sibling as the beneficiary, then distributions used for the student's expenses are treated as support that a sibling provides, not income to the student. Luna: Wait, but that only works if the student and the sibling are in separate households, right? Lucas: Well, actually, there's a nuance there. The FAFSA asks about the student's household. If the sibling lives with the student, the distribution could still be counted as parent income in some cases. So it's not a slam dunk, but it's worth exploring. The key is to plan ahead. Luna: So what about the ownership itself? Is it better for a grandparent to own the plan or to transfer ownership to the parent? Lucas: That's a big decision. If the grandparent owns it, the asset doesn't count on the FAFSA, which is good. But the distributions count as student income, which is bad. If the parent owns it, the asset counts at a reduced rate, up to 5.64 percent, and distributions are not counted as income. So sometimes shifting ownership to the parent can actually improve aid eligibility, even though the asset is on the FAFSA. Luna: But if the grandparent moves money into a parent-owned 529, isn't that a gift? Could that trigger gift tax? Lucas: Yes, it's a gift to the parent, who is the account owner, but it's still within the annual exclusion if it's under eighteen thousand. And if it's more, they could use the lifetime exclusion, which is currently over thirteen million dollars. So for most people, it's not a tax issue. Luna: Okay, so let's talk about the practical side. A grandparent calls me and says, 'I want to put fifty thousand into a 529 for my grandkid. What do I do?' Lucas: First, I'd ask whether they want to keep control of the account. If they do, they can open their own 529 and superfund it, but they need to file Form 709 and elect to spread it over five years. And they need to be aware of the financial aid implications down the road. Luna: And if they don't care about control? Lucas: Then it might make sense to contribute to a parent-owned plan. That way, the money is already in the right bucket for aid purposes. But there's a catch: the grandparent has to be careful not to exceed the annual exclusion, or they'll need to file a gift tax return, which is not a big deal but it's paperwork. Luna: What about the new rule that allows 529 funds to be used for student loan repayments? Does that apply to grandparent-owned accounts? Lucas: It does. Up to ten thousand dollars per beneficiary, and the same for each sibling. So a grandparent could use a 529 to pay down a grandchild's student loans, tax-free, as long as it's within the lifetime limit. That's a nice option for families who have leftover funds. Luna: That's a good point. But what about the five-year election? If a grandparent superfunds and then the grandchild doesn't go to college, can they switch beneficiaries to another grandchild? Lucas: Yes, you can change the beneficiary to another family member without penalty, and it doesn't reset the five-year clock. So that flexibility is nice. But there's a nuance: if the grandparent dies during the five-year period, the remaining contributions may be pulled back into their estate. That's a tricky area, and I'd recommend talking to an estate attorney if that's a concern. Luna: Okay, so let's talk about the financial aid form itself. The FAFSA for the 2026-2027 school year is already out, and it uses what's called the Student Aid Index. How do grandparent-owned 529s factor into that? Lucas: So the Student Aid Index doesn't ask about grandparent-owned 529s as assets. That's still the case. But the income question remains. If a grandparent-owned 529 pays for tuition, that money is reported as untaxed income to the student, and it can reduce aid eligibility by up to fifty cents on the dollar in some cases. Luna: That's a big hit. So what's the timing strategy? If a grandparent waits until the student's final year to take distributions, does that help? Lucas: It can, but you have to be careful. The FAFSA looks at prior-prior year income. So if you take a distribution in the student's junior year, it affects the aid for their senior year. If you take it in the senior year, it won't affect aid for that year, but it could affect a later year if they go to grad school. So it's about planning the distribution schedule. Luna: What if the grandparent contributes to a 529 that's owned by a trust? Is that a thing? Lucas: You can have a trust own a 529, but it gets complicated. The trust itself would be the account owner, and the grandchild would be the beneficiary. For financial aid, the trust's assets might not be reportable, but distributions could still count as income. Honestly, for most families, a simple individual ownership is cleaner. Luna: Got it. So what's the one thing you'd tell a grandparent who's thinking about opening a 529 today? Lucas: I'd say, first, understand the trade-off between control and financial aid. And second, if you're planning to contribute a large sum, use the five-year election to minimize gift tax issues. And third, keep the lines of communication open with the parents so you're not stepping on each other's toes when it comes to aid strategy. Luna: And maybe talk to a financial advisor who specializes in education funding. This stuff has so many moving parts. Lucas: Absolutely. But the good news is, a little planning can go a long way. We've seen families save thousands in taxes and protect their aid eligibility just by making a few intentional choices. Luna: So, bottom line: grandparents can absolutely be part of the 529 equation, but they need to be strategic about ownership and distributions. Lucas: Exactly. And if you're a grandparent listening, don't let the complexity scare you. Start with a small contribution, learn the ropes, and you can always adjust. The important thing is to get started and take advantage of the tax benefits while they're still available. Luna: Thanks for joining us on this episode. We'll have more on college savings strategies next time.