What is a grandparent-owned 529 college savings plan? How do they work? What do you need to know about them and what changes should you know about?
A grandparent-owned 529 plan is a type of 529 college savings plan where the account owner is a grandparent, as opposed to a parent. The grandchild is the beneficiary.
Another alternative would be a custodial 529 plan account, where the grandchild is both the account owner and beneficiary, but the grandparent serves as custodian. There is no limit on the type of 529 plan where grandparents can make contributions. Grandparents can contribute to grandparent-owned 529 plans, custodial 529 plans, and parent-owned 529 plans.
Keep in mind that grandparent-owned 529 plans have a different impact on eligibility for need-based financial aid than parent-owned 529 plans. Here's what you need to know if you're interested in a grandparent-owned 520 plan.
What To Know If You’re An Account Holder
If you’re a grandparent, there are several reasons why you may or may not want to be the account owner. The most important factors of account ownership include tax implications, financial aid, and estate planning.
- You are in control of the funds: By serving as the account owner, as opposed to contributing to a parent-owned 529 plan, the grandparent retains control over the account. This might be necessary to ensure that the money is spent for the grandchild’s benefit if the parents are spendthrift.
- You can tap into the funds if you need it: You can take back the money from a 529 plan account as a non-qualified distribution, if necessary.
- Tax benefits: You may need to be the account owner to claim a state income tax break.
- You don't need a ton of info to open an account: The grandparent can keep the plan a secret from the parents and grandchildren to surprise the family when they announce they’ve saved 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 owner (or spouse of the account owner) to claim a state income tax break.
529 Plans Provide Significant Estate-Planning Benefits
Contributions to a 529 plan, up to the annual gift tax exclusion, are immediately removed from the contributor’s estate, even if the contributor retains control over the 529 plan as the account owner.
Status of Gifter | How Much You Can Gift Per Year Without Being Taxed |
|---|---|
Single | $17,000 |
Married | $34,000 |
A five-year gift-tax averaging, also known as superfunding, allows contributors to give a lump-sum contribution up to five times the annual gift-tax exclusion and have it treated as occurring over a five-year period.
For example, you can give up to $85,000 (5 x $17,000) per beneficiary or you and your spouse can give up to $170,000 per beneficiary.
A portion of the gift is removed from your estate each year. Giving a lump sum allows the beneficiary to immediately invest the full amount, instead of just a fifth of the amount each year.
See more on 529 plan contribution limits here.
Earnings Accumulate On A Tax-Deferred Basis
Qualified distributions are entirely tax-free. Qualified distributions include amounts spent on college costs, such as:
Qualified distributions may also be used to pay for up to $10,000 per year in elementary and secondary school tuition.
Qualified distributions can also be made to repay up to $10,000 in the beneficiary’s student loans and $10,000 for each of the beneficiary’s siblings. (With a change in beneficiary, the 529 plan can also be used to repay up to $10,000 in 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 taxable at the recipient’s rate, plus a 10% tax penalty. The recipient may be the beneficiary or the account owner.
The tax penalty is waived if the beneficiary has passed away, is disabled or received:
- A tax-free grant or scholarship such as the American Opportunity Tax Credit (AOTC), Lifetime Learning Tax Credit (LLTC)
- Attended a U.S. military academy
- Veterans educational assistance
- Employer-paid educational assistance up to the amount of the education benefit
Generation-Skipping Transfer Taxes
When a grandparent contributes to a 529 plan for a grandchild, they may be subject to Generation-Skipping Transfer Taxes (GST).
GST occurs when the beneficiary is 37.5 years younger than the donor. However, GST does not apply if the grandchild’s parents are both dead. GST is subject to the same exclusions and exemptions as gift taxes. In particular, the $17,000 annual gift tax exclusion and 5-year gift tax averaging applies.
If you want to give more, you will use up part of your lifetime exemption, which was $12.92 million in 2023 ($25.8 million for a couple).
Most people will not have to pay GST or gift taxes. However, if you give more than $17,000 to a beneficiary in a single year, you will need to file a U.S. Gift (and Generation-Skipping Transfer) Tax Return, IRS Form 709.
Impact on Financial Aid
The financial aid impact depends on who owns the account, which affects how the 529 is reported as an asset on the Free Application for Federal Student Aid (FAFSA), and how distributions are reported as income on the FAFSA. See the following table to understand ownership, how it's reported on the FAFSA, and how qualified distributions are counted.
Owner | How It's Reported On FAFSA | Qualified Distributions |
|---|---|---|
Dependent Student | Parent asset | These are ignored |
Dependent Student's Parent | Parent asset | These are ignored |
Independent Student | Student asset | These are ignored |
Anyone Else: Grandparent, Aunt, Uncle, Non-Custodial Parent | Not reported as an asset | These count as untaxed income to the beneficiary |
In all cases, the earnings portion of a non-qualified distribution is included in adjusted gross income (AGI) on the recipient’s federal income tax return. Therefore, it’s reported as income on a subsequent year’s FAFSA.
How 529 Plan & Distributions On FAFSA Affects Student’s Eligibility For Need-Based Financial Aid
Parent assets reduce eligibility for need-based financial aid by as much as 5.64%. Student assets reduce eligibility for need-based financial aid by as much as 3.29% if the student has dependents other than a spouse. It is reduced by 20% if the student does not have dependents other than a spouse.
Qualified distributions from a 529 plan that is owned by anybody other than the student or a dependent student’s custodial parent will reduce eligibility for need-based financial aid by as much as 50% of the distribution amount.
The qualified distribution is reported as untaxed income to the student on the FAFSA. Student income, both taxed and untaxed, is partially sheltered by an income protection allowance. Half of any income above the income protection allowance will reduce eligibility for need-based financial aid.
For example, if there is $10,000 in a 529 plan owned by a dependent student or the dependent student’s parent, it will reduce the student’s aid eligibility by up to $564.
If the 529 plan is owned by an independent student, it reduces aid eligibility by up to $2,000.
If the 529 plan is owned by a grandparent, a qualified distribution of $10,000 will reduce aid eligibility by as much as $5,000.
6 Workarounds For Grandparent-Owned 529 Plans
There are many workarounds for the severe negative impact a grandparent-owned 529 plan can have on the grandchild’s eligibility for need-based financial aid.
1. Change account owner: The grandparent can change the account owner to the parent, if allowed. Some 529 plans only allow a change of account owner if the account owner dies. Some 529 plans will recapture state income tax breaks if the account owner changes.
2. Roll it over: The grandparent can rollover a year’s worth of funds to a parent-owned 529 plan. The parent-owned 529 plan must be in the same state as the grandparent-owned 529 plan to avoid recapture of the state income tax breaks attributable to the rollover.
3. Wait until sophomore year: The grandparent can wait until Jan. 1 of the student’s sophomore year in college, if the student will graduate within four years, to take a distribution. Since the FAFSA uses two-year-old income data, distributions after this date will not be reported on the FAFSA.
4. Wait until graduation: If the family is unsure how long it will take the student to graduate, they can always wait until after the student has graduated to take a distribution. Distributions in the same tax year as the expenses can satisfy the requirements for a qualified distribution.
5. Take a qualified distribution: The grandparent can take a qualified distribution of up to $10,000 each for the beneficiary and siblings to repay their student loans. The grandparent can also repay up to $10,000 in parent loans if they change the beneficiary to the parent.
6. Leave some of the funds: Grandparents can always leave leftover money in the account, as there is no requirement to take a distribution. There are no age or time limits.
Important Change with FAFSA Simplification
Grandparent-owned 529 plans will no longer affect the student’s eligibility for need-based financial aid starting with the 2024-2025 FAFSA because of FAFSA Simplification.
FAFSA Simplification eliminates the cash support question, which is where untaxed income to the student was previously reported.
This means that grandparent-owned 529 plans will not be reported as an asset and qualified distributions will not be reported as income on the FAFSA. (Non-qualified distributions will continue to be included in income.)
The 2024-2025 FAFSA is based on 2022 income, so qualified distributions from a grandparent-owned 529 plan starting in 2022 will no longer affect aid eligibility.
Want to learn more about 529 plans? Check out our ultimate guide.
More information about 529 plans can be found in IRS Publication 970.
The statutory language concerning the tax treatment of 529 plans can be found in the Internal Revenue Code of 1986 at 26 USC 529.
The statutory language concerning the financial aid treatment of 529 plans can be found in the Higher Education Act of 1965 at 20 USC 1087vv(a)(B)(2) and (f)(3).
Mark Kantrowitz is an expert on student financial aid, scholarships, 529 plans, and student loans. He has been quoted in more than 10,000 newspaper and magazine articles about college admissions and financial aid. Mark has written for the New York Times, Wall Street Journal, Washington Post, Reuters, U.S. News & World Report, MarketWatch, Money Magazine, Forbes, Newsweek, and Time. You can find his work on Student Aid Policy here.
Mark is the author of five bestselling books about scholarships and financial aid and holds seven patents. Mark serves on the editorial board of the Journal of Student Financial Aid, the editorial advisory board of Bottom Line/Personal, and is a member of the board of trustees of the Center for Excellence in Education. He previously served as a member of the board of directors of the National Scholarship Providers Association. Mark has two Bachelor’s degrees in mathematics and philosophy from the Massachusetts Institute of Technology (MIT) and a Master’s degree in computer science from Carnegie Mellon University (CMU).
Editor: Claire Tak Reviewed by: Robert Farrington