As a grandparent, you probably take a certain amount of pleasure in showering your grandkids with the occasional extravagance. That takes me to a story shared by my colleague Michael Graci, an investor education and retirement specialist here at BlackRock.
Mike’s sister was contemplating the idea of buying her nine-year-old granddaughter a pony for her birthday. Mike tallied the potential cost in his head (horse, boarding fees, veterinary bills, feed, saddle, bridles and, of course, riding lessons). Consummate professional (and good brother) that he is, Mike suggested she take that pony money and put it into a 529 plan for her granddaughter’s education. Tax-free growth over the years could potentially add hundreds if not thousands of dollars to that investment. “You may not win the ‘grandmother of the year award’ today,” he told her, “but in nine or 10 years …”
Mike was onto something, and I wanted to continue our conversation. So here is the abridged version for my readers, particularly all of you grandparents looking to gift your grandkids with something that is, in so many ways, priceless — a college education.
Rob Kron (RK): Should a grandparent open a separate 529 account or contribute to one the parent has established?
Mike Graci (MG): Most states allow you to contribute to a 529 created by someone else, but a grandparent can also create an account on behalf of a grandchild. This makes the grandparent the account owner, with full authority over the assets — when and how they are used, and for whose benefit. If you opt to contribute to a 529 created by someone else, or when assigning ownership of your account to a successor, make sure it is someone you have confidence will use those assets prudently.
RK: Why aren’t more grandparents opening 529s?
MG: 529 plans are only about 15 years old. Many grandparents did not have access to them when they were planning for the education of their own children, and many still do not know these programs exist. That was certainly the case with my sister.
RK: Will the grandparent’s 529 hurt the student’s chance of getting financial aid?
MG: Yes and no. There’s a common perception that financial aid implications may be less onerous when the grandparent is the 529 account owner. While it’s true that assets owned by a grandparent are not reported on a student’s federal financial aid application (FAFSA), be aware that any of those plan assets that are used to pay for college are reportable on the FAFSA the following year as student income. This potentially reduces the amount of future aid. For this reason, some students opt to use the assets held in a grandparent-owned 529 in the final year of college since they will not be filing a FAFSA the following year.
RK: And what about gift-tax consequences for the grandparents?
MG: Whether grandparents contribute to a 529 account they own or to a parent-owned account, the contribution is a gift to the account beneficiary. For contributions over $14,000, the grandparent may elect to treat up to $70,000 of the contribution as a gift made over a five-year period. This election allows the grandparent to “front-load” contributions into the 529 plan without exceeding the $14,000 annual gift tax exclusion. For example, a grandparent could make a $70,000 contribution to a grandchild’s 529 account in 2015 and avoid the gift tax as long as the grandparent does not make any other gifts until 2020. And it’s possible you could contribute even more (the lifetime gift credit is currently $5.43 million). We recommend discussing the possibilities with a financial advisor.
RK: What if the grandparent needs to enter a nursing home or is seeking Medicaid to cover medical expenses?
MG: Many grandparents wonder whether 529 monies are counted among their total assets should they need nursing home care or Medicaid benefits. The answer is “yes” in most states, but it’s really no different than the treatment applied to IRA assets, for example. The government will ask that you use your own money to provide care for yourself before it will pay for your care. Taxes (and potential penalties) will vary by state. There are ways to manage this, however, and we always recommend speaking with a tax or legal professional.
One final point: If you decide to transfer the 529 account to someone else’s name or even if the assets are used by the beneficiary for college, be aware of “look-back” rules. This means the government can look back a certain number of years on that activity when determining Medicaid eligibility.
RK: I hate to ask, but what if the grandparent passes away?
MG: The 529 account does not end or terminate upon death of the owner. Most, if not all, 529 account applications suggest the owner name a successor owner upon death. So the account will continue under the new owner chosen by the grandparent. If a successor is not designated, a new account owner may have to be decided through probate.
RK: And your sister, did she opt for the horse or the 529?
MG: She bought the horse, but she tells me she is still going to open a 529. She’ll be hearing from me again.
For more on college planning and 529 plans, consider these resources:
BlackRock’s College Planning Webinar, our College Planning Tool, a one-stop online destination for the college-bound; my related blog post, which gives you the opportunity to test your 529 knowledge; and 529 authority savingforcollege.com
Rob Kron, Managing Director, is the head of Investment and Retirement Education for BlackRock’s U.S. Wealth Advisory group. He provides practical information on topics that are important to every saver and investor of every age.
This material is provided for educational purposes only and does not constitute investment advice. The information contained herein is based on current tax laws, which may change in the future. BlackRock cannot be held responsible for any direct or incidental loss resulting from applying any of the information provided in this publication or from any other source mentioned. The information provided in these materials does not constitute any legal, tax or accounting advice. Please consult with a qualified professional for this type of advice.
©2015 BlackRock, Inc. All rights reserved. BLACKROCK are registered trademarks of BlackRock, Inc., or its subsidiaries. All other marks are the property of their respective owners.