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AUGUST 4, 2021

Can I open a 529 account for a grandchild?

Answered by
Richard Polimeni
Director, Education Savings Programs, Bank of America
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 a certain amount to a beneficiary's 529 account each year (PDF), free from federal gift taxes. And, if you'd like, you can make a lump-sum contribution of five years' worth of contributions, in one year. 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. The specific details surrounding the gift tax exclusion can be complicated. Please consult your tax and/or legal advisor for guidance.
Scenario #1 Scenario #2
Year 1 Up to $75,000 Up to $15,000
Year 2 Year two No contribution Up to $15,000
Year 3 Year three No contribution Up to $15,000
Year 4 Year four No contribution Up to $15,000
Year 5 Year five No contribution 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.
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Merrill, its affiliates, and financial advisors do not provide legal, tax, or accounting advice. You should consult your legal and/or tax advisors before making any financial decisions.
Before your client invests in a Section 529 plan, they should be provided the plan's official statement and read it carefully. The official statement contains more complete information, including investment objectives, charges, expenses and risks of investing in the 529 plan, which they should consider carefully before investing. They also should consider whether their home state or their beneficiary's home state offers any state tax or other state benefits such as financial aid, scholarship funds and protection from creditors that are only available for investments in such state's 529 plan. Section 529 plans are not guaranteed by any state or federal agency.
To be eligible for favorable tax treatment afforded to the earnings portion of a withdrawal from a Section 529 account, such withdrawal must be used for "qualified higher education expenses," as defined in the Internal Revenue Code. The earnings portion of a withdrawal that is not used for such expenses is subject to federal income tax and may be subject to a 10% additional federal tax, as well as applicable state and local income taxes. The additional tax is waived under certain circumstances. The beneficiary must be attending an eligible educational institution at least half time for room and board to be considered a qualified higher education expense, subject to limitations. Institutions must be eligible to participate in federal student financial aid programs. Some foreign institutions are eligible. You can also take a federal income tax-free distribution from a 529 account of up to $10,000 per calendar year per beneficiary from all 529 accounts to help pay for tuition at an elementary or secondary public, private or religious school. Qualified higher education expenses now include expenses for fees, books, supplies and equipment required for the participation of a designated beneficiary in an apprenticeship program registered and certified with the Secretary of Labor under the National Apprenticeship Act and amounts paid as principal or interest on any qualified education loans of the designated beneficiary or sibling of the designated beneficiary, up to a lifetime maximum of $10,000 per individual. Distributions with respect to the loans of a sibling of the designated beneficiary will count towards the lifetime limit of the sibling, not the designated beneficiary. Such repayments may impact student loan interest deductibility. State tax treatment may vary for distributions to pay for tuition in connection with enrollment or attendance at an elementary or secondary public, private or religious school, apprenticeship expenses and payment of qualified education loans.
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