There's nothing like the heart of a grandparent for their grandchildren. That fact hasn't been missed by financial services firms who seek to cash in on all that mushy love. They've stepped up their appeals to get grandparents to fund 529 plans for their grandchildren.
“Brokers are aggressively pushing 529 plans to grandparents to gain a good payday for themselves,” says Ted Sarenski, CPA, certified financial planner and founder of Blue Ocean Strategic Capital. “If a grandparent had six grandchildren and maximized the gift to each grandchild of $70,000 that is $420,000 going into 529 plans at once. A grandfather and grandmother joining in gifting makes that $840,000 – a good payday for a broker if they put them in a 529 plan paying a 5% commission,” says Sarenski.
But, profits in the pockets of brokers aside, what should grandparents know before plunking down their hard earned cash for a 529 plan for their grandchildren?
Why 529 plans are worth considering
“Just when you thought you had all your retirement planning done, along comes those wonderful additions to life called grandchildren. Once we have sufficiently spoiled them with whatever toys, clothes and other grandparently accessories to our hearts content, many will consider helping to defray the enormous costs associated with their future education needs. That is where the consideration of 529 plans comes into play,” says Roy Laux, president, Synergy Financial Services.
529 plans are extremely attractive in light of the American Taxpayer Relief Act passed earlier this year, says Jennifer Williams, a certified financial planner with SunTrust Investment Services. Why? Grandparents in higher income tax brackets can fund a 529 plan for grandchildren and shelter the earnings on those dollars from ordinary income taxes (39.6% max rate), plus avoid the 3.8% Medicare surcharge, she says. Earnings and withdrawals are tax-free to the extent they are used to pay for higher education expenses.
Furthermore, 529 plans are a good estate planning tool. Grandparents can put $70,000 all at once (5 times the annual exclusion amount for gifts of $14,000) and have that amount removed from their estate at the time of the gift, points out Sarenski.
However, grandparents who are in poor health should be mindful that they need to survive five years after the gift is given to have the full amount removed from their estate. “If they only live three years after the gift, 2/5ths of what they had put into the 529 plan is included in their taxable estate,” says Sarenski.
The good news is though, the gift and estate tax has been made permanent at $5.25 million, so even if a portion of the 529 contribution is added back to the grandparents' estate, the dollars may avoid the estate tax, if their taxable estate is less than $5.25 million, says Williams.
Smart move for you?
While there are plenty of good reasons to do a 529 plan, there are key considerations. First, understand how they work. Administered by numerous fund families and drawn up to reflect the specifics of individual state plans, there can be a lot of confusion about 529 plans, says Laux. Most plans are funded using mutual funds as the growth engine of the plan. You choose between age-related funds designed to match the plan's risk orientation to the time line associated with the date college classes will begin, explains Laux. Or, you can elect to manage the funds yourself. Typically, you invest less aggressively the closer your future college freshman is to starting classes, and more aggressively when they are younger. While you do not receive a federal tax deduction for the funds invested, if you live in the state that issues the plan, you may see a state income tax benefit, says Laux.
Some states offer plans that allow you to pay the cost of a current tuition credit, and guarantee your payment made today will cover that credit when the beneficiary (your grandchild) needs it. As long as the funds are used for education, no income taxes are paid.
One of your first questions, should be to ask your children which state plan they would like to set up the 529, says Elle Kaplan, CEO and founding partner of Lexion Capital Management.
Before investing, consider whether your home state or your designated beneficiary's home state offers any state tax or any other benefits that are available to residents of that state. Any state tax benefits associated with a 529 plan apply only to residents of the state sponsoring the plan.
Know too, that the state you choose for your 529 plan matters for another reason too. One important consideration is who will be the custodian of the plan for the minor child. Many grandparents choose their children (the parent), rather than themselves. Regardless of who is chosen to be the custodian, it is recommended that the grandparent choose a 529 plan domiciled in a state that offers asset protection, so if they chose their child as custodian, and their child files for bankruptcy, or is sued, the funds are protected from creditors. Many states, but not all, offer this protection.
”You do not need to be a resident of the state where the 529 plan is domiciled, so choosing a state with credit protection is recommended regardless of where the grandparent lives,” says Williams.
While you are doing your part to help your grandchild, 529s also carry a downside for them. 529 plans are considered the grandchild's asset when applying for financial aid. A large 529 plan account could limit the financial aid they would get, especially if the parents (the grandparent's kids) are not well off and the grandchild could get a lot of financial aid if the 529 didn't exist.
“Grandparents should think about whether they want to instead, just write checks to the college directly for the benefit of the grandchild. The amounts paid are not limited by the $14,000 maximum exclusion amount. You could still give them $14,000 per year beyond the direct payments to the college,” says Sarenski.
Because there is much to assess and understand, get a financial advisor to weigh in on which plan is best for your situation or whether you should go forward with a 529 plan for your grandchild at all.