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Published on: 12/26/2023

What You Need To Know About 529 Accounts for Grandchildren

As costs of education rise, many high-net-worth families are thinking about how to fund the education of generations to come — and 529 accounts for grandchildren are a popular and powerful way to do so. 

529 plans are tax-advantaged savings accounts designed specifically to fund education and education-related expenses. Although they are typically used for children, 529 accounts can also be established for grandchildren and even great-grandchildren.

In this article, the financial advisors from Avidian Wealth Solutions are here to discuss the ins and outs of 529 accounts for grandchildren, including eligibility and ownership, the pros and cons of choosing a Texas 529 plan, and the 529 grandparent loophole. 

What 529 plans does Texas have?

Texas has three 529 plans that are sponsored by the state:

  1. The Texas College Savings Plan (TCSP)
  2. The Lonestar 529 Plan (LS529)
  3. The Texas Tuition Promise Fund (TTPF)

All 529 plans can be used to pay for education expenses and all offer at least some tax advantage. However, the major difference between the three plans is that the TTPF allows contributions to be made for future expenses at current rates, while contributions to the TCSP and LS529 must be withdrawn (and spent) at a later date, and therefore at a different (likely higher) market rate. 

The best 529 accounts for grandchildren will depend on what is best for you, the owner of the account itself. If you are unsure, don’t hesitate to discuss it with a trusted financial advisor.

Can grandparents open a 529 plan for grandchildren?

Yes! Grandparents can open 529 plans for their grandchildren, both for their grandchildren’s benefit and their own. 529 plans, when used in tandem with other high-net-worth tax strategies, can offer significant tax advantages and monetary flexibility that trusts and other planning solutions can’t offer on their own. 

It’s important to note that while grandparents can open and contribute to a 529 plan, they should be mindful of any gift tax implications. Contributions to a 529 plan are considered gifts and are therefore subject to annual and lifetime gift tax limits set by the Internal Revenue Service (IRS). 

What to know about the 529 grandparent loophole

Is it better for a grandparent or parent to own a 529 plan? While starting a 529 plan for college students is generally a great way to fund college and save the family money, there are benefits to grandparents owning a 529 plan instead of parents. Why?

When students apply for Federal Student Aid (FAFSA), they are required to calculate the expected amount of money that their family will provide for their college expenses. Students can only receive federal aid if their expenses are higher than this Expected Family Contribution (EFC). 

EFC is calculated based on the student’s income, their parent’s income, and their parent’s assets. For high-net-worth families, this EFC is almost always higher than their expected education expenses and makes many students from high-net-worth families ineligible for federal aid. 

So what is the 529 grandparent loophole? If a student’s parents open a 529 plan, the money in that 529 account counts towards their assets, raising their EFC — but gifts from grandparents do not. Distributions from 529 accounts owned by grandparents do not count towards this EFC and therefore do not affect eligibility for federal aid programs, making grandparent-owned 529 plans one of a few powerful high-net-worth strategies you can use to plan your estate.

Pros and cons of 529 plans for grandparents

529 plans are a way for high-net-worth grandparents to fund their grandchildren’s education and benefit from tax advantages at the state and federal levels — and it often takes very little work. Some benefits of a 529 plan include:

  1. Tax advantages. Although contributions are made after tax, earnings in a 529 plan accumulate tax-free, and qualified withdrawals are also tax-free. 
  2. Control and flexibility. You remain in control of the assets in the account and the designated beneficiaries of the account until the day the funds are distributed. 
  3. Estate planning options. Utilizing the gift tax exclusion can make owning a 529 account a very powerful estate planning solution for high-net-worth grandparents. 
  4. Ability to convert to a Roth IRA. Beneficiaries can convert up to $35,000 (lifetime) from their 529 funds to a Roth IRA starting in 2024, although these contributions cannot exceed the annual Roth contribution limits. 

While 529 plans are a versatile and powerful estate planning tool, they won’t always be right for every family. Some possible disadvantages of grandparents owning 529 plans can include:

  1. Penalties on some withdrawals. If you need to withdraw money from the 529 account before it is distributed you will need to pay income taxes on any earnings, as well as a 10% penalty on the earnings if the money is not used for qualified education expenses. 
  2. Limited investment options. If you want to play an active role in your investments in the 529 account, you may be disappointed to find out that 529 plans generally offer a limited selection of very conservative investments. 
  3. Distributed money counts as student income. As of now, gifts (once distributed) count as student income, which counts towards EFCs and can negatively impact your grandchildren receiving federal aid. The passing of the FAFSA Simplification Act will change the federal form to no longer include gifts from grandparents, but certain colleges will still ask for supplemental information that might be used against your grandchild.

In order to get the most out of your 529 account, you should work with trusted tax and financial advisors who can leverage the 529 plan alongside other estate and tax planning solutions, to help you make sure that you’re getting the most from your money and leaving behind a legacy for generations to come. 

Thinking about starting 529 accounts for grandchildren in your family? Avidian can help. 

529 accounts for grandchildren can be an invaluable tool for grandparents looking to financially support their grandchildren’s education and plan their estate simultaneously. Whether grandparents choose to own the plan themselves or involve the parents, careful consideration of the tax implications and impact on financial aid for the student is essential. 

While the 529 grandparent loophole offers an intriguing strategy for maximizing benefits, setting up and managing a 529 account requires thorough planning and strategizing if you want to serve the needs of your grandchildren and your estate. 

If you’re curious about what a 529 plan can do for your grandchild (and your taxes) the financial advisors at Avidian Wealth Solutions are here to help. Avidian offers estate planning in Houston, Austin, Sugar Land, and The Woodlands in a boutique family office environment. 

Schedule a consultation with us today to ask how we can help you optimize your wealth and simplify your life. 

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