Multi-Generational Planning: Funding a 529 Plan for Your Grandchildren

Annrose Isaac CPA, CFP®, MBA
Annrose Isaac CPA, CFP®, MBA
529 plan

A college education does not come cheaply. Forbes has estimated that the price of a college education has increased 8 times faster than wages, making it important for families to plan ahead in order to fund educational expenses. At Wade Financial Advisory, Inc. (WFA), we routinely discuss the benefits of establishing an Education Savings Plan account (commonly known as a 529 plan account) with our clients.  These accounts provide a cost-effective way to benefit the future generation because grandparents and other family members can easily contribute to a child’s existing 529 plan account. Setting up a 529 plan account as early as possible and adding funds to the account regularly allows for maximum growth opportunity.

529 Accounts are Easy to Open

529 plan accounts can be easily opened up online in a few minutes with a small initial contribution.  Once opened the account owner can allow grandparents, friends, and family members to contribute to the account by providing the needed contribution instructions to their loved ones.  For example, California’s state-sponsored 529 plan called the CA ScholarShare plan allows accounts to be opened with an initial one-time contribution of just $25.  Money can then be added to the account to save for the child beneficiary’s future education expenses.  529 plan accounts typically offer a range of investment options including mutual funds and exchange-traded funds.  The investment options also include static fund portfolios and age-based portfolios (sometimes called target-date portfolios).  Typically age-based portfolios automatically shift toward more conservative investments as the child beneficiary gets closer to college age.

Withdrawals from a 529 Plan Account

Withdrawals from education savings plan accounts can generally be used at any college or university, vocational or trade school, and some international colleges and universities. Originally designed to save money for college expenses, a change in the tax law passed in 2017 now allows 529 plan funds to be used to pay up to $10,000 per year per beneficiary for tuition at any public, private, or religious elementary or secondary school.

Taxes & 529 Accounts

The IRS doesn’t specify an annual contribution limit for 529 plans but contributions into a 529 plan account are considered to be a gift to the account beneficiary.  Under the current tax laws, each individual is allowed to gift up to $15,000 per year to as many people as they like without having to file a gift tax return.  Gifts in excess of this amount trigger the need to file a gift tax return.  This means that a single parent or grandparent could gift up to $15,000 into each of their children/grandchildren’s 529 plan accounts in 2021 without filing a gift tax return.  Married parents or grandparents could gift up to $30,000 into each child/grandchild’s account in 2021.

Super-Funding Your 529 Plan

529 Plans also have a unique feature that allows for super-funding the accounts by making large contributions in one year and using 5-year gift tax averaging for those contributions.  Here, a single parent/grandparent could gift up to $75,000 into each child/grandchild’s 529 plan account in 2021 if he/she elects to treat the contributions as though they were spread over a 5 year period starting in 2021.  The 5-year election is made by filing gift tax returns electing the 5-year gift averaging.  Similarly, married parents/grandparents could gift up to $150,000 to each of their children/grandchildren’s 529 plan accounts in 2021 by taking advantage of this 5- year election.

What You Need to Know About 529 Account & Deductions

There are numerous income tax benefits associated with 529 plan accounts.  Some states (although not California) allow residents to claim income tax deductions when they contribute to the 529 plan account sponsored by that state. Investment earnings inside a 529 plan account always grow tax-deferred (much like they do inside 401k and IRA accounts) until they are withdrawn at some point in the future.  Additionally, money can be withdrawn tax-free from a 529 plan account if the funds are used for qualified higher education expenses (QHEE) including tuition, room and board, fees, books, and supplies that are required for college attendance.  Account owners will pay taxes as well as a penalty (10% federal and 2.5% CA) only on the earnings portion of distributions from 529 plan accounts that are not used to pay for QHEE.  No taxes will be owed on the original investment whether or not it is used for education purposes.  For instance, suppose $20,000 has been contributed to a 529 plan and the current plan balance is $25,000.  The account owner will only pay taxes and a penalty on the $5,000 in earnings if the entire balance is withdrawn from the 529 plan account and used for non-education-related expenses.  No taxes will be owed if the $25,000 is used entirely to pay for QHEE.

Reading The Fine Print on 529 Accounts

Under federal law, 529 plan balances cannot exceed the expected cost of the beneficiary’s qualified higher education expenses. Limits vary by the state sponsoring the 529 plan, ranging from $235,000 to $529,000 because the limit is intended to cover the cost of attending an expensive college and graduate school in the state. The CA ScholarShare plan allows for a maximum balance per beneficiary of $529,000.  There is not a “use it or lose it” restriction on 529 plans.  Therefore, money saved in a 529 plan account will not be lost even if plan funds are not used for educational purposes.  In this case, withdrawals from the 529 plan account will simply be subject to taxation and penalty as noted above.  Those who may be concerned about the possibility that their child/grandchild will not end up attending college need not worry because the account beneficiary can simply be changed to another member of the child/grandchild’s family who will be attending college.  Additionally, 529 plan funds can be withdrawn penalty-free up to the amount of the yearly scholarship received if a child/grandchild beneficiary of a 529 plan account is also a scholarship recipient.

Income Eligibility: Can I Open a 529 Account? 

The parents’ income level continues to be the key factor affecting eligibility for college financial aid.  Money saved in 529 plan accounts will have an impact on eligibility for college financial aid but parent-owned 529 plan accounts receive more favorable treatment in the financial aid formulas than grandparent-owned 529 plan accounts.  Therefore, a grandparent who does not need ongoing access to the funds can contribute to the 529 plan account that has been set up by the parents. On the other hand, a grandparent who would like to maintain control over the funds can open up separate 529 plan accounts for each of their grandchildren.

Grow Your Family’s Wealth with Wade Financial Advisory

529 plan accounts can be opened upon the birth of a child.  It is best to start as early as possible to allow for maximum growth opportunity.  Please let your Financial Advisor know if you would be interested in learning more about 529 plan accounts.

Helping families preserve and protect wealth across generations is one of the many services offered by Wade Financial Advisory, Inc.  Contact us if you would like to learn more about how we can partner with you to grow and protect your family’s wealth.

This communication contains the opinions of Wade Financial Advisory, Inc. about the securities, investments and/or economic subjects discussed as of the date set forth herein. This communication is intended for information purposes only and does not recommend or solicit the purchase or sale of specific securities or investment services. Readers should not infer or assume that any securities, sectors or markets described were or will be profitable or are appropriate to meet the objectives, situation or needs of a particular individual or family, as the implementation of any financial strategy should only be made after consultation with your attorney, tax advisor and investment advisor. All material presented is compiled from sources believed to be reliable, but accuracy or completeness cannot be guaranteed. PAST PERFORMANCE DOES NOT GUARANTEE FUTURE RESULTS. INVESTMENTS BEAR RISK INCLUDING THE POSSIBLE LOSS OF INVESTED PRINCIPAL.

Wade Financial Advisory, Inc. is an investment adviser registered with the Securities and Exchange Commission. Registration of an Investment Advisor does not imply any level of skill or training. A copy of current Form ADV Part 2A is available upon request or at www.advisorinfo.sec.gov. Please contact Wade Financial Advisory, Inc. at (408) 369-7399 with any questions.

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