September is a big month for many families: Students are back in school and Grandparents’ Day takes place on September 12th. In honor of these annual traditions, the following is an anecdote about how I recommended that loving grandparents use 529 college savings plans to meet both their estate planning needs and help their grandchildren prepare for a successful future, academically and financially.
Joan* and Peter* are proud parents and grandparents. While Joan and Peter do not have the luxury of living close to their families, they have the benefit of substantial assets that enable them to afford a comfortable lifestyle. They retired in their 50s from their respective careers and enjoy tremendous flexibility around how they spent their time and enjoyed their wealth. When we first started working together, I asked Joan and Peter what brought them happiness. Peter immediately responded, “Our family. Our family is very important to us.” As we developed Joan and Peter’s financial plan, I encouraged them to consider financial goals that they needed to address, such as daily expenses as well as financial goals they wished to experience over time, like sharing their wealth with others. Joan confided in me, “I’d like to give money to the family while I’m alive so that I can see them enjoy it, rather than wait until I’m dead and miss out on the fun.” Peter quickly chimed in, saying that he agreed—but he wanted to be smart about how they did it. With that vision, I proposed that they open and super fund a 529 college savings plan for each of their grandchildren.
plans are tax-advantaged ways to save for education expenses.
What Are 529 College Savings Plans?
529 college savings plans are tax-advantaged ways to save for education expenses. For those familiar with retirement savings plans, 529 plans are like ROTH IRAs in that you benefit from favorable tax treatment if you follow certain rules. 529 plans are operated by states and institutions, and money in the accounts can be invested in a variety of ways. Contributions to the plans may be tax deductible to the owner of the plan on the state level. Earnings and withdrawals from the 529 plans are federal income tax-free if they are used on qualified education expenses. Qualified education expenses have expanded over time to include:
- tuition, books, fees, and other supplies at the college and graduate levels
- up to $10,000 annually in K–12 tuition expenses
- $10,000 annually to repay qualified student loans
Owners of 529 plans designate a beneficiary for the plan. If the beneficiary does not end up using the funds, the owner can change the beneficiary to another family member.
How Much Can You Contribute to a 529 Plan Each Year?
Since contributions to 529 plans are considered “gifts” to the beneficiary of the account, an individual can contribute up to the annual gift-tax exclusion—or $15,000 in 2021—to a beneficiary’s 529 plan before additional tax considerations. A couple that files their taxes as “Married Filing Jointly” can contribute $30,000.
What Does It Mean to “Superfund” a 529 College Savings Plan?
There is a special 529 plan funding strategy available called “five-year gift tax averaging” or “super funding.” It enables a donor to contribute five years’ worth of annual gifts all at once. This means that an individual taxpayer can contribute up to $75,000 to a beneficiary’s 529 plan in a particular year; a married couple filing a joint tax return can contribute $150,000. In exchange for making this gift, the donor cannot make any more gifts to the beneficiary for the next five years. And for the contribution to not be counted in the estate of the donor, the donor needs to live for five full years after making the gift.
Do Grandparent-Owned 529 Plans Affect Financial Aid (FAFSA)?
Grandparent-owned 529 plans are not reported on the Free Application for Federal Student Aid (FAFSA). However, historically, cash distributions from grandparent-owned 529 accounts needed to be reported on the next year’s FAFSA. To avoid this, some grandparents were careful around when they made 529 plan distributions. It is important to note that FAFSA is changing and, once effective, cash support including distributions from grandparents’ 529 plans will no longer have to be disclosed.
Why Are 529 Plans Attractive to Grandparents?
Contributions to 529 plans:
- Reduce grandparents’estate tax exposure
- Enable grandparents to retain control over the account, including:
- How to invest the funds
- What to use the funds for
- When to disburse the funds
- Whether to change the beneficiary
Circling back to Joan and Peter, when I advised them that they could simultaneously do good for their children, grandchildren, and themselves, they were ecstatic. Joan and Peter could not wait to open the accounts, share the exciting news with their family, and witness their loved ones enjoy their wealth and set themselves up for academic and financial success, too. If you crave strategic, tax-aware advice on your financial choices like Joan and Peter, I am right here.
* Joan and Peter are pseudonyms.
The clients’ names have been changed and some details generalized for this article.
Caroline Wetzel is one of Natural Nutmeg’s 10Best Winners for Business/Life Coach. Caroline is a Certified Financial PlannerTM (CFP®) and Vice President, Private Wealth Advisor with Procyon Private Wealth Partners, LLC. Procyon Private Wealth Partners, LLC and Procyon Institutional Partners, LLC (collectively “Procyon Partners”) are registered investment advisors with the U.S. Securities and Exchange Commission (“SEC”). This article is provided for informational purposes only and for the intended recipient[s] only. This article may also include opinions and forward-looking statements which may not come to pass. Information is at a point in time and subject to change. Procyon Partners does not provide tax or legal advice.