Personal Finance

529 Plans: A Tax-Efficient Way to Fund Your Grandchildren's Education

Tim Herrera, Janney’s Director of Mutual Funds and ETFs, explores the advantages and considerations of using 529 plan accounts to save for and help fund your grandchildren’s college education.


When grandparents are given the gift of grandchildren, they are often filled with the desire to do anything they can to help, financially and beyond. In fact, according to the AARP, grandparents spend approximately $179 billion on their grandchildren every year.

One of the most important gifts a grandparent can give is to provide funding for their grandchildrens’ educational needs.

Section 529 of the IRS Code provides a tax-advantaged savings vehicle which allows grandparents to establish a 529 Plan account and appoint a grandchild as the beneficiary of that account.

While 529 Plan accounts were originally designed to provide for higher education/college funding, the 2018 Tax Cuts and Jobs Act expanded the scope of 529 Plans to allow them to now be used to fund private K-12 education expenses as well.

Advantages of 529 Plan Accounts
There are several advantages to using 529 Plan accounts from a grandparent’s perspective:

Contributions are Treated as a Completed Gift:
Each contribution that a grandparent makes to a 529 Plan account is treated, for tax purposes, as a completed gift. In most States, the 529 plan contributions, by way of the completed gift, can accrue a state tax benefit for the grandparents (be sure to consult your local tax advisor for an understanding of your state’s potential tax benefits). Each grandparent may contribute up to $15,000 per year ($30,000 per couple) to any individual grandchild’s account, the current federal gifting limit.

Superfunding:
This term is interchangeable with forward gifting or max-funding. However you coin it, there is a unique provision within Section 529 of the IRS Code that allows 529 Plan account owners to gift up to five year’s worth of contributions within a single year. This superfunding provision means that grandparents can contribute up to $75,000 per beneficiary ($15,000 x 5 years) in a single year. That figure doubles to $150,000 if both grandparents contribute to an account for the same beneficiary.

Maintaining control of your assets:
In contrast with other types of gifts, 529 Plan account contributions remain under the control of the account owner/grandparent and can only be used according to the will and by the direction of the grandparent. The beneficiary/grandchild cannot access the funds for any reason.

Removing assets from your estate:
This benefit is one that too few people consider when they talk about opening a 529 Plan account. Although the primary purpose of these accounts is to provide for education funding for children/grandchildren, contributions to the 529 Plan accounts are treated as completed gifts, all contributions have the effect of reducing a grandparent’s estate by the full amount of the contributions. Many states allow for up to $350,000, and in some cases more, in lifetime contributions, which further enhances this benefit.

Tax-deferred growth:
 All investment gains, dividends, capital gains, and interest earned within a 529 Plan account grow on a tax-deferred basis. Earnings are tax-deferred but can be withdrawn tax-free when used for permitted education expenses. If you take the money out for a non-permitted education expense or a different use, you pay a penalty plus taxes on the portion of earnings that are outside the deferred window.

Tax-free withdrawals for qualified higher education (or K-12) expenses:
Any withdrawals that are made from a 529 Plan account that are used for qualified higher education or primary (K-12) education expenses will be exempt from any tax burden.

Things to Consider
The advantages of grandparent-owned 529 Plans typically outweigh any potential issues that come with funding a grandchild’s education, but there are a few potential pitfalls that should be taken into consideration.

Potential taxes on distributions:
If withdrawals from the 529 Plan account are used for any reason other than qualified education expenses, the earnings portion of the withdrawal would be subject to a 10% penalty and it would be taxed at the grandparent’s ordinary income tax rate.

Withdrawals/distributions: Withdrawals/distributions from a grandparent’s 529 Plan account are required to be reported as untaxed income to the student on the subsequent year’s FAFSA Application, and they are assessed at a 50% rate, whereas distributions from parent-owned 529 Plan accounts are assessed at a 5.6% rate.

 – There are two ways to avoid this additional penalty:
• Delay the use of the grandparent-owned 529 Plan account until the student/grandchild is entering their junior year of college, due to the method of calculating student income on the FAFSA form.

• The grandparent could transfer ownership of the account to the parent. Although by using this method, the grandparent effectively cedes control of the assets to the parent.

• If a grandparent chose to superfund a 529 Plan account and they were to pass away during the five-year period, then a portion of the contribution would be “recaptured” into their estate for estate-tax purposes.

Timothy J. Herrera
Director of Mutual Funds and ETFs
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Tim Herrera serves as Director of Mutual Funds & ETFs within Janney’s Wealth Management Department. He joined the Firm in October 2007 and has over 25 years of experience in the financial industry. Mr. Herrera leads strategic partner relationship efforts with Janney’s Mutual Fund, ETF, 529 Plan, and Alternative Investment product partners, and he also provides support to the growth of Janney’s fee-based/advisory platforms.

Prior to joining Janney, Mr. Herrera served in various leadership roles with ADP, The Bank of New York and JP Morgan. A graduate of Hofstra University with a BBA in Banking and Finance, Mr. Herrera also holds the FINRA Series 7, 66 and 31 licenses and he attained the Accredited Wealth Management Advisor (AWMA®) designation through the College of Financial Planning®.

This does not constitute tax, legal, or accounting advice. For tax, legal, or accounting advice, please contact the appropriate professional.

This is for informative purposes only and in no event should be construed as a representation by us or as an offer to sell, or solicitation of an offer to buy any securities. The factual information given herein is taken from sources that we believe to be reliable, but is not guaranteed by us as to accuracy or completeness. Opinions expressed are subject to change without notice and do not take into account the particular investment objectives, financial situation, or needs of individual investors. Employees of Janney Montgomery Scott LLC or its affiliates may, at times, release written or oral commentary, technical analysis, or trading strategies that differ from the opinions expressed within.

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