Are you thinking about opening a 529 College Savings Account for your grandchild?
It may be more advantageous to make a financial gift to your grandchild instead.
We’ll dive into why grandparents may want to shy away from opening their own 529 College Savings Accounts for a grandchild – and what method might leave everyone better off.
Taxes on 529 College Savings Accounts
The main reason opening a 529 college savings plan for your grandchild is not ideal is simple: taxes.
Unfortunately, contributing to a grandchild’s 529 account 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% 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. (If you’re a CA resident, check out this comprehensive guide on California 529 plans.)
The reality is, 529 plans can be valuable tools when it comes to funding a grandchild’s college education.
That’s because the money you contribute grows without being taxed. This tax advantage – growth without taxation – is often referred to as a tax-deferred investment.
When a student uses the money from a 529 plan for qualified educational expenses (such as tuition and books), they don’t pay income tax on the distributions.
In short, if you use a 529 for its given intention (i.e. higher education expenses), it becomes a tax-deferred AND a tax-free way to invest.
Should a Grandparent Open a 529 College Savings Account?
One thing to consider when establishing a 529 plan is who should own the account.
To qualify for federal financial aid, distributions from a 529 College Savings Plan owned by a grandparent are counted differently than distributions from a 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 account.
In this case, be sure to write down the account information when you open the account so you can send in a check when you wish.
Some 529 accounts even send out “deposit checks” that can be given to relatives who want to make a deposit. Be sure to ask if this is an option.
Of course, this strategy only works if you are confident your child will use the money as intended and not used for something else.
Where to Open a 529 Account for Your Grandchild
So, how do you know which 529 plan is the best?
Because investment costs are the biggest driver of investment returns, you want to be careful to select the right plan. Thankfully, several low-cost 529 plans exist across the country.
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 always choose from several other saving and investing options.
Either way, time is of the essence.
Whether you use a 529 plan or something else, start saving right away. Your grandchild may be an infant or toddler now, but college will be here before you know it.