Many families take advantage of 529 College Saving Plans and don’t realize how to use them for tax benefits without risking their financial aid. It’s imperative withdrawals from these savings plans are for the correct reasons in order to avoid income tax; for example, withdrawing for tuition or room and board. According to Forbes, here are some benefits you should know about and how to capture their benefits.
One method is for grandparents to use an estate-tax angle. They are able to add a max of $75,000 to college savings per grandchild by pre-claiming five years of gift tax exclusion. This means that there is a possibility of the grandparents taking the money back later, as long as the person who withdraws lives five years within that period.
Another benefit is there is a possible income tax credit or tax deduction for donors depending on whether or not that specific state allows that type of account subsidy.
An important thing to understand is the difference between who the account owner is, parent versus grandparent, which will change how the accounts interact with charges. If it is a typical case in which the parents are the owners of the account, then it is treated as a normal bank account where the balance gets charged about 5% a year.
However, if a grandparent is the owner, then instead of the balances being assessed, it is generally the withdrawals that were made that get charged, and therefore the financial impact is greater. One way for grandparents to work around these charges is to play around with switching who the account beneficiary is.
Basically what this means is that when grandparents set up a beneficiary account, instead of setting the beneficiary as the intended person to receive the money, they would set it as someone else for the time being. Therefore, that account and balance shows up nowhere on the assets for the actual intended beneficiary or their family.
Then, at the last moment, the grandparents would change it to the intended beneficiary in time for the money to be disbursed to them, but too late for financial aid to lower your need-based aid. This can be tricky depending on different difficulties you would need to monitor such as what state you live in, as some do not allow for change of beneficiaries.
Another issue would be if the grandparent passed away before the change of beneficiaries. So while this can be risky, it can be helpful in avoiding thousands of dollars of need-based aid being reduced or removed.
Something to keep in mind is the potential for penalties to be assessed. If you were to remove money from your 529 account in order to use the funds for something other than education (such as an emergency), the withdrawal is subject to income tax and a 10% penalty. However, it is prudent to remember that the earnings are what are penalized, not the entire withdrawal, and that if you had not invested in the 529 account, those earnings would have been taxable either way.
If you are unsure how to proceed with opening a 529 plan, or the best way to use the funds to support the student in college without impacting financial aid, be sure to speak with a financial planner and/or a college financial advisor.
