Benefit Financial Services Group
linkedinfacebook
HomeTag: #educationalplanning

#educationalplanning

New FAFSA Rules Around Grandparent Owned 529 Plans

By: Henry VanBuskirk, CFP®, Wealth Manager

One of the biggest decisions that a person about to graduate from high school can make in life is whether or not they choose to go to college. That’s also why it’s no coincidence that when toymaker Milton Bradley was designing the board game, The Game of Life®, one of the first things you do in the game is to decide whether or not your character will go to college.1 In the real world, electing to go to college is not as easy of a decision. The actual game of life is much more complicated. Going to college means a significant financial cost for you and your loved ones that has outpaced inflation over time. To highlight this, take the University of Pennsylvania’s tuition and associated expenses in 1960 (the year that the board game Life® was published).

Now fast forward to the 2020-2021 academic year for the University of Pennsylvania and the price tags have increased drastically:

I’m not here to preach one way or the other on whether or not this is wrong. I’m just here to point out that this is the reality we live in. If you went to college in the early 60s, imagine what life was like for you. If you have grandchildren, chances are that you want them to have a better start to the game of life than you did. If their parents do not have the means to fund college, then they will have to use student loans and fill out the FAFSA (Free Application for Federal Student Aid) to receive financial aid to help pay for those post-secondary education goals.

You may want to contribute to an investment vehicle to help them save for college. The most popular investment vehicle for saving for future college expenses is the 529 plan. There have been new changes to the 529 plan and how it interacts with the FAFSA form. My goal today is to show you how you can take advantage of these new changes to help your grandchildren have a better opportunity to graduate from college and have a fulfilling career of their choosing.

What is a 529 plan?

A 529 plan is an investment account that is sponsored by states, agencies, or investment companies, that grows tax-free, and distributions can be tax-free as long as the distributions are made to pay for qualified education expenses (such as tuition or room and board). In 2023, you can contribute up to $17k per person, per beneficiary. There is also the option to “superfund” a 529 plan, which would be making 5 years of contributions to the 529 plan in one year.  This is where you can put $85,000 into the 529 in year one (5 * $17,000) but cannot make additional contributions until year 6. This can also be used to help mitigate the size of your taxable estate at the time of your death. However, careful planning must be done since if the 529 plan is super funded and you pass away within the 5 years of super funding, the 529 plan as the contribution would then be added back to your estate.

The FAFSA Rules

The old FAFSA Rules when it came to grandparent-owned 529 plans were that distributions from the 529 plan would be counted as non-taxable income to the student and 50% of the distributed value would impact potential financial aid. This would impact the Expected Family Contribution (EFC), potentially meaning that less federal financial aid would be awarded to the student.

The new rules are that distributions from a grandparent-owned 529 plan are not counted at all towards FAFSA and are not considered non-taxable income to the student. The EFC is not impacted, and the grandparent-owned 529 plan is just assumed to not exist when it comes to awarding federal financial aid to the student. Keep in mind, however, that grandparent 529 plans are still considered on the CSS Profile (an additional financial aid form used by about 200 private colleges to award their institutional aid).

The rules for a parent-owned 529 plan are that the first $10,000 of a 529 plan account is excluded from FAFSA and only 5.64% of the account’s value above $10,000 is factored into the EFC when filing the FAFSA and determining any potential federal financial aid.

What does this mean for you?

If education planning is important to you and your family, it may be more beneficial to focus on having a greater balance in a grandparent-owned 529 plan rather than a parent-owned 529 plan. There also may be options to change the owner of a 529 plan from a parent to a grandparent, depending on the state that your 529 plan is in. If you have both a parent-owned and a grandparent-owned 529 plan, it is important to coordinate the distributions from each account for the optimal financial aid available for the student. Due to the new Secure Act 2.0, there is also the ability to roll over up to $35,000 of funds in a 529 plan to a Roth IRA for the beneficiary if the beneficiary chooses not to go to college. The funds had to be in the 529 plan for at least 15 years to take advantage of this and the amount that can be rolled over each year is subjected to the annual Roth contribution limits.

Conclusions

As a grandparent, now your grandchildren have all of the tools they need to succeed in any post-secondary education that they choose. You sit down with your grandchild, explain that you started a 529 plan to save for their future post-secondary education goals, and they give you a hug since they know that they can fulfill their dreams now because of you:

Ok, maybe some dreams should be scrutinized. I’m guessing you probably don’t want your legacy walking around in oversized shoes, wearing multicolored overalls, and donning a large fake red nose (and I’m not here to judge if that is what you want for your legacy).2 If you wish, you can also change the beneficiary on the 529 plan at any time and as often as you like. Since Bart isn’t planning on using the funds in the 529 plan wisely, it may be prudent for you to change the 529 plan beneficiary to his more responsible sister, Lisa:

While Bart is upset that he won’t get any funds from the 529 plan (he’ll just need to pull himself up by his oversized bootstraps and work hard to finance his Clown College tuition), you and Lisa are ecstatic to learn how the new FAFSA rules for grandparent-owned 529 plans and how you contributing to a grandparent-owned 529 plan can bolster your grandchild’s future educational endeavors and help instill your personal morals and values to the next generation.3

Legacy planning is one of the most important financial planning topics that we address with our comprehensive financial planning services. If you are in a comfortable financial position where you are looking to help others in your family succeed by passing on your personal morals and values, we can help you fulfill those goals. To summarize, I would like to point out this chart from the National Center for Education Statistics:

To reference another board game from my childhood (this time from Hasbro), don’t take the Risk® of waiting to discuss your grandchildren’s future education needs with your family and your financial planner.4 The above chart shows that delaying this conversation means funding future education goals will only become more difficult over time. That hurdle can be conquered by setting up an investment vehicle like a 529 plan to fund future education expense needs now. Our team of Certified Financial Planner™ (CFP®) professionals is here to construct your comprehensive financial plan and be a sounding board for you to voice how you want your family legacy to be remembered by future generations. We’re here to help you win at this game of Life® (at least financially) and the first step to playing is by giving us a call at 714-282-1566 or emailing us directly at financialplanning@bfsg.com to schedule an appointment with our team.

Footnotes:

  1. https://en.wikipedia.org/wiki/The_Game_of_Life. Also sometimes called Life®.
  2. Bart from The Simpsons
  3. Lisa from The Simpsons
  4. https://en.wikipedia.org/wiki/Risk_(game)

Sources:

Disclosure: BFSG does not make any representations or warranties as to the accuracy, timeliness, suitability, completeness, or relevance of any information prepared by any unaffiliated third party, whether linked to BFSG’s website or blog or incorporated herein and takes no responsibility for any such content. All such information is provided solely for convenience purposes only and all users thereof should be guided accordingly. Please remember that different types of investments involve varying degrees of risk, and there can be no assurance that the future performance of any specific investment or investment strategy (including those undertaken or recommended by Company), will be profitable or equal any historical performance level(s). Please see important disclosure information here.

Best Account to Open for Your Kids Future

By:  Paul Horn, CFP®, CPWA®, Senior Financial Planner

As parents we always want to see our kids succeed and do better than we did. This means many times we want to invest in their future for various things. Most of the time parents want to save for education, but there could be other reasons to save.  For example, helping them buy their first home, seed money to start their business venture, or to pay for a wedding. Below are the most common account types and when it may be the best choice based on your goals for the money. Some may notice that the Coverdell (Educational IRA) is not listed and that is because it is no longer relevant given recent changes to the 529 Plan.

529 Plan: Best account for saving for education

  • Best used if you 100% know that the beneficiary is going to use the funds for college, post-secondary education, or private school.
  • For 2022, the max that can be contributed in one year is $16,000 per person per beneficiary (or $32,000 with gift splitting).  There is also an option to superfund a 529 where 5 years of contributions are made in one year.
  • Contributions grow tax-free and distributions can be tax-free as long as they are used for qualified education expenses.  Qualified education expenses include (but are not limited to) items like room and board, tuition, and books.
  • Contributions can be deductible at the state level depending on your state.
  • If the distribution is not for qualified education expenses, the earnings on the distribution are subjected to ordinary income taxes and a 10% withdrawal penalty.
  • You can switch the beneficiary at any time. Let’s assume you have money left over after the oldest child graduates; you can transfer this money to the next kid in college.

UTMA/UGMA (custodial account): Best account if you want your kid to have the money at 18 or 21 without any limitations

  • In 2022, this is an account where the custodian can contribute $16,000 per year to an investment account for a minor child.  At the age or majority (usually age 18 but can be increased to age 21 or 25 in some circumstances), the minor child then becomes the owner of the account.
  • While the minor child is still listed on the UTMA (Uniform Transfer to Minors Act) account or UGMA (Uniform Gift to Minors Act) account, the earnings are subject to capital gains at the following schedule:
    • The first $1,100 of unearned income is free from tax,
    • The next $1,100 is taxed at the minor’s tax rate,
    • Earnings above $2,200 are taxed at the parent’s tax rate.
  • When the account transfers to the minor child due to the minor child reaching the age of majority, earnings and distributions are taxed at capital gains tax rates.

2. Put money into a taxable account in your name – Best option for anything not education specific

  • There are no limits on how much you put into the account or how the money is used.
  • You maintain full control of the assets and determine when and how much they receive.
  • This is a taxable account, so it would be subject to regular taxes (i.e., interest income, capital gains, dividends, etc.)
  • If your kid(s) were to inherit the taxable account, the securities in the taxable account get a step up in basis to virtually eliminate any tax implications for them.
  • A taxable account has less impact on financial aid for your kid(s) than a UTMA/UGMA.
  • Money can be invested however you choose.
  • When you give the money to them it is considered a gift and limited to $16,000 per person or $32,000 for a married couple per year (2022). Any amount over this is reported on a gift tax return (no taxes are paid but it reduces your estate tax exemption).
  • If the money is used to pay tuition for a school directly or directly to medical bills, then the $16,000 limit does not apply.

Roth IRA: Best if saving for their retirement

  • Contributions to a Roth IRA can be made for a minor child as long as the minor child has earned income from working.
  • For 2022, contributions are limited to $6,000 or the amount of earned income (whichever is lower). Assume they make $3,000 from a summer job, then you are limited to contributing $3,000.
  • A parent can put money into the Roth IRA for the kids to allow the kids to keep their income they earned.
  • Contributions grow tax-free and distributions can be tax-free if the owner (the minor child) is at least age 59.5 and the contributions have been in the account for at least 5 years.  If not, earnings on the distributions are subject to ordinary income tax and subject to a 10% early withdrawal penalty.  There are some instances where the 10% early withdrawal penalty can be waived that include (but are not limited to): buying your first home (up to $10k), college tuition, or permanent disability.

As you can see, there are many options available to you and the best account depends on what your goals are. You can reach us at financialplanning@bfsg.com if you would like to have a complimentary call to discuss your specific situation.

Disclosure: BFSG does not make any representations or warranties as to the accuracy, timeliness, suitability, completeness, or relevance of any information prepared by any unaffiliated third party, whether linked to BFSG’s website or blog or incorporated herein and takes no responsibility for any such content. All such information is provided solely for convenience purposes only and all users thereof should be guided accordingly. Please remember that different types of investments involve varying degrees of risk, and there can be no assurance that the future performance of any specific investment or investment strategy (including those undertaken or recommended by Company), will be profitable or equal any historical performance level(s). Please see important disclosure information here.