Yes, you most certainly can open a 529 account as a grandparent — you generally can name anyone as a beneficiary of a 529 account.
These accounts can be a useful financial tool for both grandparents and their grandchildren. In addition to using 529 assets for college expenses, you may use up to $10,000 per year per beneficiary from all 529 accounts to pay for the beneficiary's tuition in connection with enrollment or attendance at an elementary or secondary, private, public or religious school. You also can use the assets for expenses related to a registered and certified apprenticeship.Footnote 1
Are contributions to a grandchild's 529 account tax-deductible?
While 529 contributions are not tax-deductible on the federal level, many states allow residents to take a state income tax deduction for contributions to your state's 529 plan. Federal tax law permits you to contribute up to $15,000 for 2021 (or $30,000 for a married couple electing to split gifts) to a beneficiary's 529 account each year, free from federal gift taxes. And, if you'd like, you can make a lump-sum contribution of five years' worth of contributions, or $75,000 ($150,000 for a married couple electing to split gifts), in one year.Footnote 2 This gives your contribution more time to potentially grow tax-deferred. But, you will have to wait five years to make another contribution, to avoid paying taxes on your gift or having it count against your lifetime unified credit.
Two ways to contribute to a 529 |
| |
Scenario #1 |
Scenario #2 |
| Year 1 |
Up to $75,000 |
Up to $15,000 |
| Year 2 |
Year two |
Up to $15,000 |
| Year 3 |
Year three |
Up to $15,000 |
| Year 4 |
Year four |
Up to $15,000 |
| Year 5 |
Year five |
Up to $15,000 |
| Benefit |
More time for investment to grow |
More manageable contributions |
| Source: Merrill Edge based on Instructions for Form 709, Internal Revenue Service, pages 6-7 |
What are some of the other benefits of opening a 529 for my grandchild?
Consider the following 529 advantages:
- They have tax-free growth potential.
- Qualified withdrawalsFootnote 1 (think: tuition, room, board, books, etc.) are free of federal — and, in most cases, state and local taxes.
- Unused funds are transferable to a relative of the beneficiary, tax-free.
As noted above, a 529 account can allow investment earnings to grow, exempt from federal (and possibly state and/or local) income taxes, and withdrawals that are used to pay for qualified higher education expensesFootnote 1 — such as tuition, fees, room, board or books — are tax-free. Assets in a 529 account for your grandchild will not impact your grandchild's ability to receive federal financial aid while in the account. However, withdrawals from the account to pay for college expenses will be treated as non-taxable income to your grandchild in the following year and may impact federal financial aid eligibility through FAFSA (Free Application for Federal Student Aid).
To avoid having a grandparent 529 impact financial aid, try waiting until after January 1 of the beneficiary's sophomore year in college to take a distribution. Since the FAFSA uses the prior-prior year for income and tax information, there will be no subsequent year's FAFSA to be affected by the distribution if the student graduates in four years.
Could the 529 plan I choose limit my grandchild's college choices?
You can participate in plans sponsored by other states as well as those in your own. It doesn't matter where you or your grandchild live — or even in which state your grandchild plans to attend school. Keep in mind that some states offer their residents a state tax deduction on contributions to a 529 account (in many cases the deduction only applies if you contribute to a 529 account in your home state). When choosing a 529 plan, you'll want to compare fees, investment options and lifetime contribution limits, which may differ from state to state.