Do your parents want to help your kids with college costs? Or are you a grandparent who wants to chip in? That is great news! After all, tuition sticker shock is escalating from headache to heart attack levels.
However, grandparents should know their gift may affect the loans and grants that students get. Without careful planning, years of saving may accomplish nothing but reducing the student’s financial aid eligibility. Fortunately, there are ways to help the younger generation with college that minimize the impact on financial aid.
529 Plans: Know the Rules
You have probably heard of 529 plans, which are accounts designed to help families save for college by offering tax-deferred growth. What you may not know is that the way you set up a 529 plan affect student aid eligibility.
Financial aid officers base the family’s expected contribution on two things: assets and income. Who those assets and income belong to makes a difference in their impact. Assets and income belonging to the student matter the most; those belonging to the parent second. Assets and income belonging to grandparents generally don’t impact financial aid at all.
The availability of tax or other state benefits (such as financial aid, scholarship funds and protection from creditors) may be conditioned on meeting certain requirements, such as residency, purpose for or timing of distributions, or other factors.
Grandparents have two options when using a 529 plan to save on a student’s behalf
Set up their own account
Contribute to a 529 account owned by the parents
Both approaches have potential financial aid impacts.
The Grandparent-Owned Account
If the grandparent owns the 529 account, it is not counted as part of the student’s or parents’ assets. So it doesn’t affect student aid eligibility—until the grandparent starts using it. Tuition paid from a grandparent’s 529 account is considered untaxed income of the student, which can drastically reduce aid.
How to avoid this pickle? Some grandparents opt to contribute to 529 accounts set up by the parents. Such gifts count as assets rather than as income¹ and make a smaller dent in aid eligibility. Federal financial aid rules dictate that parents contribute up to 5.64% of their assets toward the cost of attending college², but students are expected to contribute a whopping 50% of most untaxed income.³
Depositing savings into a 529 plan owned by the student’s parents is easier than you may think. In fact, with the Learning Quest 529 Education Savings Program, students can share a Ugift® code with grandparents or even set up a gifting web page.
Patience Can Be a Value
One way for grandparents to avoid hurting student aid eligibility is to wait awhile. The SECURE Act, passed in 2019, allows people to pay up to $10,000 loans per student using 529 plans. So if grandparents wait until after graduation, they can use 529 funds to pay some of the student's loans.
Another way grandparents’ patience can pay off: wait until after the child is in college. Because the Free Application for Student Aid (FAFSA) looks at past years’ income, any tuition help after Jan. 1 of the student’s sophomore year will not affect aid for the final two years—assuming the student will graduate in four. Grandparents can avoid impacting aid eligibility by focusing their help on the second two years of school.
One caveat: the federal rules described here affect what families report on FAFSA. The CSS Financial Aid PROFILE form, administered by the College Board and used to determine eligibility for non-government aid, employs a different formula.
Trends in College Pricing, 2020, The College Board. October 2020.
Does a 529 Plan Affect College Financial Aid? savingforcollege.com, January 2021.
Cappex, How to Increase Eligibility for Need-Based Financial Aid, https://www.cappex.com/articles/money/increase-need-based-financial-aid, January 2021.
Finaid, Account Ownership: In Whose Name to Save? https://finaid.org/savings/accountownership, January 2021.
Before investing, carefully consider the plan's investment objectives, risks, charges and expenses. This information and more about the plan can be found in the Learning Quest Handbook, available by contacting your financial advisor or American Century Investment Services, Inc., Distributor, at 1-800-579-2203, and should be read carefully before investing. If you are not a Kansas taxpayer, consider before investing whether your or the beneficiary's home state offers a 529 Plan that provides its taxpayers with state tax and other benefits not available through this plan.
As with any investment, withdrawal value may be more or less than your original investment.
IRS Circular 230 Disclosure: American Century Companies, Inc. and its affiliates do not provide tax advice. Accordingly, any discussion of U.S. tax matters contained herein (including any attachments) is not intended or written to be used, and cannot be used, in connection with the promotion, marketing or recommendation by anyone unaffiliated with American Century Companies, Inc. of any of the matters addressed herein or for the purpose of avoiding U.S. tax-related penalties.
This information is for educational purposes only and is not intended as tax advice. Please consult your tax advisor for more detailed information or for advice regarding your individual situation.
The earnings portion of non-qualified withdrawals is subject to federal and state income taxes and a 10% federal penalty.
Notice: Accounts established under Learning Quest and their earnings are neither insured nor guaranteed by the State of Kansas, the Kansas State Treasurer or American Century Investments.
Administered by Kansas State Treasurer Steven Johnson
Managed by American Century Investment Management, Inc.
American Century Investment Services, Inc., Distributor