Should Grandparents Own the 529 Plan Instead?
Have you heard the following question from any of your clients who want to help grandchildren with college costs:
Should I contribute to a 529 plan that I would own, or is it better to contribute to a parental 529 account?
The answer to this question requires more than a simple yes or no. But you can help your generous older clients make the right move by understanding the different scenarios.
First, let’s explore the reasons to open a grandparent-owned 529 and then why it won’t always be feasible.
Reasons Why Grandparents Should Own Their Own 529:
1. Some grandparents will prefer contributing to their own 529 rather than giving it to the parents to save because they don’t trust that the money will still be there for college.
2. Grandparents who contribute to a 529 account that they control would like to capture a tax benefit. Owning a 529 can be desirable if the grandparent lives in one of the 27 states with a state income tax that offers a tax credit or deduction for 529 contributions.
3. In an additional nine states with state income taxes, grandparents can potentially claim a 529 tax deduction even if their contributions were made to a different state’s 529 plan. This perk is commonly referred to as tax parity.
Here are the states that fall into this category:
4. A handful of states, including New York, Massachusetts, Rhode Island and Montana, limit the state tax deduction solely to the registered account owner or their spouse. In these states, if a grandparent writes a check into a parent-owned account, the grandparent can’t claim the tax deduction, and often neither can the parent.
5. Funds withdrawn from a grandparent 529 account for college expenses no longer count when assessing aid eligibility for the grandchild via the Free Application for Federal Student Aid. Previously, the FAFSA asked about 529 withdrawals by anyone outside the immediate family, and that money was harshly treated as the child’s untaxed income.
6. Owning a 529 can offer a combination of tax benefits and asset control for estate planning purposes. Unlike many traditional estate-freezing strategies, 529 plans let the grandparents continue to control the funds.
When a grandparent contributes to a 529 plan, the Internal Revenue Service treats the contribution as a completed gift to the grandchild. The money and all future growth are removed from the grandparent’s taxable estate.
Grandparents can front-load a 529 by contributing up to five years of the annual gift tax exclusion all at once. The yearly federal gift tax exclusion is $20,000 for 2027, so a grandparent could contribute up to $100,000 to a grandchild in one year, and married grandparents could double that.
Reasons Not to Own a Grandparent 529:
1. Logistically, a grandparent account can end up being a hassle and will require coordination with the parents.
Grandparents would have to coordinate with the student’s parents when 529 money is withdrawn. Withdrawing more than the calendar year’s eligible college expenses can turn that money into a taxable distribution with a 10% penalty on earnings.
Not coordinating can also result in no one being able to capture the American Opportunity Tax Credit.
2. If a grandparent dies, a grandparent-owned 529 that doesn’t have an updated successor owner designated on the 529 account can be frozen or get tied up in probate court before the family can access it for college payments.
3. In some cases, grandparents who contribute to a parent-owned 529 account can still be eligible for a tax break for their contributions. Some states require the person claiming the deduction to own the account, but others allow qualifying non-owner contributors to claim a benefit.
4. If the grandparent, who front-loads a 529 account, passes away before the five-year period concludes, a pro-rata portion of the remaining unallocated gift value is pulled back into the gross estate for tax purposes.
5. While the FAFSA no longer cares about grandparents or other generous individuals helping out with college costs through a 529, some CSS Profile colleges and universities do. Some CSS Profile institutions explicitly ask about assets held in 529 plans by grandparents or other relatives and factor those anticipated resources into their institutional aid formulas.
6. Because a grandparent can technically revoke a 529 account and withdraw funds at any time (subject to taxes and a 10% penalty on earnings), Medicaid would treat this 529 as an available countable asset of the grandparent.
6. If capturing a tax deduction or credit is the main motivation in contributing to a grandparent 529 account, some grandparents will want to reconsider. In 13 states, grandparents, parents or anyone else contributing to a 529 will not capture a tax break.
These states offer no state income tax deduction or credit for 529 contributions regardless of who makes them. Most of the states in this category have no individual state income tax, but the following do have state income taxes, but no state 529 break:
