There are many tax-advantaged ways to help fund education. Here are some pros and cons to popular tax-advantaged savings options for grandparents.

Are you wanting to help with education expenses for a child or grandchild, but aren’t sure where to start? There are many education-funding accounts available for you to choose. Here are some pros and cons to popular tax-advantaged savings options for grandparents.

529 education savings plan

A 529 plan is a state-sponsored college tuition account. These accounts are tax-deductible in many states, which can benefit you during tax season.

Pros:

• Tax advantage

  – Contributions to 529 plans are after-tax. Earnings and withdrawals are federal income tax-free when used for qualifying education expenses. This can include up to $10,000 for tuition expenses covering elementary, middle, or high school education. In addition, you can spend up to $10,000 from a 529 account for qualified student loans and certain apprenticeship programs.

• Qualified expenses

  – for college and graduate level, includes tuition, books, fees, supplies, and other eligible expenses at accredited institutions. Also, when you make an annual contribution to the 529 plan, the money is no longer considered part of your estate for tax purposes.

• Greater control

  – if you open a 529 account and name your child or grandchild the beneficiary, you can maintain control of the account. This includes control of disbursing funds, and the option to change the beneficiary. 529 plans also allow you to gift control of the account to a grandchild’s parent if you wish.

• Front-loading college savings

  – you can contribute a larger amount of funds at the account opening, without having to pay a gift tax, or lifetime gift tax exclusion. You can contribute five years’ worth of annual gifts – up to $15,000 at once, for a total up to $75,000 per person, per beneficiary. Doing this also means you can’t make any more excluded gifts to your grandchild during those five years.

• Little impact on financial aid

  – the funds you contribute to a 529 plan are considered a parental asset when calculating the Expected Family Contribution (EFC) for federal financial aid. Generally, a 529 plan will have minimal effect on the amount of aid a grandchild receives, depending on who owns the plan and when withdrawals are taken.

Cons:

• Potential impact on financial aid

  – as mentioned earlier, there’s generally little impact on financial aid. As long as you’re the owner of the account, and the account isn’t included as a parental asset in the federal EFC calculation. However, once the money is distributed, it’s considered student income. This could result in a negative impact on financial aid, if a grandchild uses it before the final two years of attendance.

• Certain withdrawal penalties

  – if you’re the owner of a 529 plan, you can withdrawal the money at any time. However, you’ll have to pay income taxes on any earnings, and a 10% penalty on earnings if you don’t use the money for qualified education expenses.

• Medicaid implications

  – a big drawback to being the owner of a 529 plan is the potential loss of Medicaid assistance. Assets in a 529 plan you set up are considered your assets for the “Medicaid means testing” process. You would have to spend the funds in a 529 account on your care, before Medicaid payments could begin.

UGMAs/UTMAs

The Uniform Gift to Minors Act (UGMA) is one of the most common custodial accounts for minors. It’s a simple way for a minor to own securities without needing the assistance of an attorney to prepare trust documents, or needing a trustee. Similarly, the Uniform Transfer to Minors Act (UTMA) allows minors to own other types of property like real estate or fine art. These types of accounts allow you to save for a grandchild, but the person named on the account would have access to funds when they reach a certain age.

Pros:

• Broad investment options

  – there’s a greater range of investment options for a custodial account. These accounts allow for investment options like stocks, bonds, and mutual funds of your choice. They also include alternative assets like insurance policies and real estate.

• No limits on contributions

  – there is no annual limit per account, and you can contribute up to $15,000 yearly per child, free of the gift-tax. You have the option of contributing any amount and any asset. While taxes may apply, consider consulting your tax attorney or accountant before contributing.

Cons:

• Less control

  – the person you name on the account gains control over the funds when they reach a specified age. Usually the age is between 18-21, which can vary by state. Once your grandchild reaches that certain age, they can use the money for anything they choose.

• Potentially less student aid

  – these types of accounts are considered a student asset, which means they are factored into the EFC at 20%. This is much higher than the 2.6%-5.6% factored for parental assets.

• Modest tax benefits

  – any interest, dividends, and capital gains earned yearly are reported under your grandchild’s Social Security number. For specific information on how investments owned by a child are taxed, read about the Tax on a Child's Investment on the IRS website.

Coverdell Education Savings Accounts (ESAs)

A Coverdell education savings account is a trust or custodial account solely for paying qualified education expenses for the beneficiary on the account. Coverdell ESAs provide a tax-deferred (and potentially tax-free) savings option if used for eligible college or other education expenses. However, eligibility and contributions are pretty limited.

Pros:

• More uses

  – you can use this type of account to save for education expenses from kindergarten through college. Any individual with an adjusted gross income under the limit set for a given tax year can make contributions.

• Tax benefits

  – any earnings and withdrawals are usually tax-free if used for qualified expenses. Distributions are generally tax-free as long as the amount of the distributions doesn't exceed your grandchild’s qualified education expenses. If a distribution exceeds their qualified education expenses, a portion of the earnings is taxable to him or her.

Cons:

• Contributions are not deductible

  – you must make contributions in cash, and they are not tax-deductible. You must contribute by the due date of the tax return (not including extensions). The total contribution to an account in any year can't exceed $2,000.

• Age limits apply

  – you can only open this account for grandchildren under the age of 18. Any contributions you make after they turn 18 are subject to a tax penalty of 6%. Typically, the beneficiary on the account must use these funds by the time they turn 30-years-old. Or they must withdrawal funds within 30 days of their 30th birthday.

• Less control

  – most ESAs require the grandchild’s parent or guardian to be responsible for the account. With someone else controlling the account, you wouldn’t have the option of transferring money or withdrawing funds.

When considering what option is right for you to help contribute to a grandchild’s education, be sure to visit with your financial advisor. There are a lot of different options for setting up an education savings account, and it’s important to be sure it aligns with your tax strategy. If there’s anything we can do to assist you, feel free to contact us. We’re ready to help you!

Sources:

How grandparents can help fund education, Fidelity

UGMA & UTMA Custodial Accounts, Finaid

"Your greatest asset is time": 3 investment accounts that can set your child up for financial success, Grow Acorns

Does a 529 Plan Affect Financial Aid?, SavingForCollege

Topic No. 310 Coverdell Education Savings Accounts, IRS.gov

While the information provided is based on our understanding of current laws, and has been gathered from sources believed to be reliable, it cannot be guaranteed. Federal tax laws are complex and subject to change. This information should only be relied upon when coordinated with individual professional advice. Neither LPL Financial, nor its registered representatives, provide tax or legal advice. Please consult with your own tax and legal advisor(s).

Prior to investing in a 529 Plan investors should consider whether the investor’s or designated beneficiary’s home state offers any state tax or other state benefits such as financial aid, scholarship funds, and protection from creditors that are only available for investments in such state’s qualified tuition program. Withdrawals used for qualified expenses are federally tax free. Tax treatment at the state level may vary. Please consult with your tax advisor before investing.

The information provided in these articles is intended for informational purposes only. It is not to be construed as the opinion of Central Bancompany, Inc., and/or its subsidiaries and does not imply endorsement or support of any of the mentioned information, products, services, or providers. All information presented is without any representation, guaranty, or warranty regarding the accuracy, relevance, or completeness of the information.

Category: Family & Estate