Does opening a 529 College Savings Account for your new grandchild make sense? Probably not. Because of the way 529 College Savings Accounts are set up and the way the money grows tax-free, it may be more advantageous to make a financial gift to your grandchild instead.
Should that gift be added to a 529 College Savings Account? Absolutely. Keep reading to learn why grandparents should shy away from opening their own 529 College Savings Account for a grandchild, and what method might leave everyone better off.
Taxes on 529 Accounts
The first reason why opening a 529 College Savings Account for your grandchild is less than optimal is a simple one: taxes.
Unfortunately, contributing to a grandchild’s 529 will not benefit a grandparent’s income taxes in the state of California. This is because contributions to a 529 are not deductible when preparing federal or state taxes in our state. In a state like Indiana where contributors get a 20 percent tax credit on the first $5,000 they contribute to a 529 plan each year, adding money to a grandchild’s 529 account makes a lot more sense. In California and many other states, not so much.
But, just because a grandparent does not get a tax deduction for putting money into a 529 doesn’t necessarily mean that using a 529 College Savings Plan is a bad deal. In fact, it’s quite the opposite.
The reality is, 529 College Savings Plans can be valuable tools when it comes to funding a grandchild’s college education. That’s because 529 College Savings Plans allow the money you contribute to grow without being taxed. This tax advantage – growth without taxation – is often referred to as a tax-deferred investment.
Also, when a student uses the money in a 529 College Savings Plan for qualified educational expenses (such as tuition and books), they don’t have to pay income tax on the distributions from the 529 College Savings Plan account. In short, if you use a 529 for it’s given intention (i.e. higher education expenses), it becomes not just a tax-deferred way to invest, but a tax-free way to invest.
Should a Grandparent Own a 529 College Savings Account?
One thing to consider when establishing a 529 plan is who should own the 529 account. In consideration for qualifying for federal financial aid, know that distributions from a 529 College Savings Plans owned by a grandparent are counted differently than distributions from a 529 College Savings Plan owned by a parent. Under certain circumstances, it can be more advantageous for a grandparent to fund a 529 plan in the parent’s name than for the grandparent to own the 529 College Savings Plan account. Of course, such a strategy only works if the grandparent is confident that any money given to the parent will indeed be deposited into the 529 account and not used for something else.
Said another way, if you’re a grandparent looking to start saving some money for your grandchild’s future education, it may make the most sense to give money to your child to invest on your grandchild’s behalf. Of course, this only works if you are confident that your child will put the money to work as requested.
Of course, you can also ask your child for account information on your grandchild’s 529 College Savings Account so you can send in a check yourself. Some 529 accounts even send out small “deposit checks” you can give to relatives that want to make a deposit on their own, so make sure to ask.
Where to Open a 529 Account for Your Grandchild
Now that you know that it makes sense for your child to open a 529 account for your grandchild, how do you know which 529 is the best? Consumer expert Clark Howard suggests several low-cost 529 plans across the country, and we think they’re worth checking out. But, why is choosing a low-cost plan important? Because investment costs are the biggest driver of investment returns!
Also, keep in mind that 529 College Savings Plans aren’t the only way to help your grandchildren save for college. If you think a 529 College Savings Plan may not be the best option for your grandchild for any reason, you can choose from several other saving and investing options for college.
Either way, time is of the essence. Whether you opt to save in a 529 or somewhere else, the best thing you can do is start saving right away. Your grandchild may be an infant or toddler now, but college will be here before you know it.