Ep # 23: Should Grandparents Own 529 Plans For Grandkids?
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Benjamin Haas 00:02
Hi everyone and welcome to A/B Conversations where we will help you CFP your way out of it. A podcast where you get into the minds of a couple Certified Financial Planners on how we think and feel about everyday financial planning questions, and what should really matter most to you. A healthier financial life starts...now!
Adam Werner 00:29
So today we're going to talk about 529 plans and I think, or at least college education expenses and how in our world, we certainly hear a lot of questions or a lot of interest from the grandparents who want to help cover those costs or contribute to plans on behalf of their grandchildren. I think part of our role is to try to lay some groundwork, the pros, the cons, there's many different ways to go about that and we're just hoping to share some of those highlights on what works best, some tips and tricks to look out for and just share some general education.
Benjamin Haas 01:17
Yeah, I think we experience it a lot where clients get most excited when talking about their grandchildren so there are many different ways that I think they could go about helping and I would say, generally, the whole domino effect of certain decisions is not really understood. I think it's really important for us to go through what some of those dominoes are and I would start right off the bat with whose asset is it? Right, so I'll give a little background and then maybe you can give me your thoughts. Most times, when some child is going to go to school, there's going to be a FAFSA form filled out called Free Application for Federal Student Aid.
Adam Werner 02:04
I think, I don't know.
Benjamin Haas 02:06
My mother would be disappointed. So that's going to get filled out and that's basically the formula that says what kind of aid is the student potentially have, is available to them, and there's this massive formula, we won't get into the details on parents assets, parents’ income, student’s income, student’s assets and I think it's really important right off the bat to think, what role can the grandparent play here in not messing up that application? So what did I mean?
Adam Werner 02:38
So what did you mean? Am I supposed to answer what you mean?
Benjamin Haas 02:41
Yeah. Why does it matter?
Adam Werner 02:45
So clearly, in part of that equation, you never once mentioned, the grandparent's income or the grandparent's assets. So that, I guess, a distinction number one.
Benjamin Haas 02:58
Bingo! So a client comes to us and says, My son has a 529 plan. I want to help with their college education. Should I just fund that plan? Why open a second one?
Adam Werner 03:12
I think that's what we see. That's the most common, right, your child who now has a child of their own, the grandchild starts a 529 plan for their own child and then that's just easily the vessel to contribute to if it already exists. That's just the path of least resistance, let's just contribute to that, build that account over time. But to your point, that is now a parental owned asset and that will show up in the expected family contribution and will need to get put towards that college education. Now, I know that is still the intent. That's why you would save for college to help pay for college but it does, it does potentially impact the amount of grants and other financial aid that is available.
Benjamin Haas 03:59
So yes, use the example of birthday money. Maybe there's special occasions, maybe it's just you want to help on a more regular basis. We can give the example of like time value of money as a good thing. In this case, you save up $100,000 for the education of the student, and it's all in the parents name. Going back to the expected family contribution, that's $5,000 or $6,000 per year, that's going to be disqualifying mom and dad from having to not have to pay for some of that education. 5.64% is the specific number. So it may not seem like a huge deal, but I mean, that's real money.
Adam Werner 04:40
Yeah and we often hear it's the mental accounting of we are trying to be diligent savers to cover this expense but now we're being somewhat penalized for also being those diligent savers to help cover these expenses and obviously there's arguments to be made there. Fact of the matter is, the more assets you have, the more income you have, it does limit the amount of free financial aid or grants that are available to students.
Benjamin Haas 05:11
So here's the flip side of that. When we think about grandparent owned 529, it is their asset. So control and accessibility would mean that if for some reason, the grandparent in this situation, goes through a tough time, maybe there's a lot of care costs that are needed, that money could be clawed back or it's not going to be able to be used for the grandchild if they need to apply for Medicaid or something of that nature. Now, I would hope we never get ourselves to that point, right? If we're going to be aggressively saving or helping with the child's education. Rule number one is take care of yourself and make sure you have the assets to do that but nonetheless, good to know.
Adam Werner 05:52
Yeah, exactly. I liken that to the year you're on a plane, you're hitting turbulence or something worse, right, the oxygen mask falls down and they tell you put the mask on yourself first and then help either your seatmate or your family member next. So same thing, for any grandparent that wants to help their grandchild or their child, more often than not, we want to make sure that their situation, their retirement looks okay, whatever, that their own costs are covered before you start to give away money that may have to come back to support your lifestyle moving forward. But I guess the other thing to know and maybe we just didn't explicitly say it, but we kind of alluded to it, kind of that loophole when it comes to the expected family contribution is for a 529 plan to be owned by the grandparent with the beneficiary listed as their grandchild. So it is still the intent to have it for the grandchild but now instead of the parent or now before if we're the grandparent, your child owning the account, you're owning the account as the grandparent directly for your grandchild and then that completely eliminates that asset from the calculation. But as with everything else we talked about, of course, there's caveats and there's one more little stipulation.
Benjamin Haas 07:17
So are you going to the domino, here? We're probably same thing.
Adam Werner 07:21
Yep. So okay, the asset doesn't get included in any given year, but the income, right, so if it's $100,000, that you have now set aside for your grandchild and you take out $10,000 to help pay for education costs in year one, that $10,000 is going to show up as if it were income for the student. Now that is going to factor into next year's FAFSA form and it's going to show up as income and it's going to show that there's going to be a higher expected family contribution, therefore less potential aid in future years.
Benjamin Haas 07:57
Right and that kid's income, just to talk about why this really is relevant. If you took out $10,000, then 50% of the kid's income is expected to go towards education above an exclusion. I'm not remembering the number is like $6,000.
Adam Werner 08:14
Yeah, $6,500, somewhere in that range.
Benjamin Haas 08:16
So in that math, that extra $3,500, 50% of that is going to be deducted from aid eligibility. Again, it's really just important to kind of understand the dominoes and try to find the sweet spots that you're comfortable with but I think those are two dominoes. The asset - who owns it and the income when it shows up, are sometimes what's not thought of when you're just trying to do the nice thing and save for the kid’s education. So I jumped to a different part of the conversation, then we often get questions then on like, how is that money managed? Or how do you go about trying to grow that money over time? Or what role is it going to play over that accumulation period between whenever you started the plan and college years? So there's two different types of plans? Maybe I'll throw it to you.
Adam Werner 09:14
So there's your typical, what we've been talking about is kind of the 529 plan, investment based account. Right, you're putting dollars in it, you have to choose some sort of investment option, as conservative as cash and as aggressive as the stock market, and that potentially will grow over time. The other side of things is, like a prepaid tuition plan where you're essentially buying college credits at today's tuition prices that can be used in the future, when theoretically they should be, rising over time with the cost of college increases is has far outpaced the level of inflation that we've certainly seen here in the last 15-20 years.
Benjamin Haas 09:59
Yeah, so I that's important to note and of course, we can't know when somebody would ask well, which one's better?
Adam Werner 10:05
Yeah.
Benjamin Haas 10:06
We don't have the ability to know where the cost of education will go. Certainly it's different when we're talking private institutions or public institutions. Who knows where legislation goes. That's certainly been in the news the last couple of years on what's going to happen with that rising cost and what can be done but it's just two different ways to go about it.
Adam Werner 10:28
So I think that the way that we often approach that is clearly there's pros and cons to each. There's caveats to each one, there's restrictions on both if you know, college changes in some way, shape, or form down the line, either specifically for that student, or there's the ideas floating out there that college education is going to be free in the future, then why should I be saving? But I think ultimately the point is, if the intent is to save, there's no wrong way to do that, it ultimately comes down to personal preference to some degree on would you rather invest it or get some sort of, quote, unquote, guaranteed, you know, future credit purchase? But it really is, there's no wrong way. The important piece really is, if your intent is to do the saving than doing a saving is step number one. Step two is deciding where to invest, that is less important to us.
Benjamin Haas 11:22
And start early, I think, this is a great example, especially for, you know, those that may be, again, are in that retirement phase of life or maybe they're just managing their own legacy plan. Now it's going to include some gifts to grandchildren, the time value of that money is just important to remember. $5,000 a year or break that down $416 a month, for 18 years, right? If you started as a baby, you know, a pretty moderate rate of return of 6%, over 18 years. So that's almost $160,000. Right? In today's math, cost of education today, that's a $40,000 a year school for four years. Yeah, that'll do it. You know, not that $416 a month is nothing but that seems kind of digestible. If you're talking about making a huge impact to the student over time.
Adam Werner 12:14
Yeah, absolutely.
Benjamin Haas 12:16
You start saving at age nine, it would take $1,160 a month to get to that same level of savings of $160,000 or if you did the $416, it's only $60,000 of savings. So just time value of money. Those are vastly different numbers no matter how you're going to say doing it early I think is key.
Adam Werner 12:40
Then I'll slightly pivot and just stop me if you don't want me to but I think there are beyond saving in advance for college, there's the other options on helping pay for those costs, either in real time. If let's say the student is already in college, the grandparent can essentially just write a check, right, cover that tuition bill directly to the college and therefore, that doesn't show up in any calculation anywhere. By the way, if you're making the check directly to the institution, then that's not a gift for IRS gifting purposes. It's never going to the child it's on behalf of for the benefit of the child. So that's one way that if grandparents or anyone wants to help fund a college education, there's no saving, right? You're not getting any tax benefit for doing that other than avoiding potentially some gifting rules. If that's one other way to help cover a cost and in the future.
Benjamin Haas 13:45
Yeah and there's certainly situations that we come across every year in helping our clients where we pretty much say, Hey, your legacy plan is set. Your job now is to efficiently get rid of these assets and that's a really nice way to do it because like you said, it doesn't go against that annual gift exclusion. So it's what's considered a nice gift and it's an easy, quick way to get money out of your estate. So I like that one, or I'll stay in that vein. It's one thing to help fund, it's another to fund while also teaching important life lessons in my opinion. That means helping them pay the college education bills, the student loans, after they're done is incentivize, they're working hard. If you continue to get good grades, if you work hard in this way, if you know you reach your goal of getting this job, then I'm going to help you pay that back is another I think, very meaningful way to make your gift that maybe wasn't on the front end of trying to leverage your dollar into growth over time.
Adam Werner 14:49
We've certainly seen that with clients. There's several examples in my head that, you put a little bit more weight on the student to kind of be an adult and take the full weight of college decision and just the costs and everything associated with that. Then by the way, at some point in the future, if that means helping them pay that off, that's just a happy surprise to them down the line.
Benjamin Haas 15:17
Yep, okay and the other one that I have on that front would be some people like to just help them get started in another way. This will be the situation where somebody comes to us and the students may be 16 or 17 years old already. Hey, I want to help with it. Well, again, putting money into a savings plan, the impact of that is pretty much gone at this point, right? You don't have that time value of money. Maybe it's helping fund a Roth IRA for them, maybe it's helping with the home down payment, maybe it's some other way outside of college savings, that you're getting them started off on the right foot and maybe teaching them some of the fiscal responsibility that we're assuming that they have because they work with us.
Adam Werner 15:59
Sure.
Benjamin Haas 16:02
I guess the only other thing that comes into my mind is when you have multiple grandchildren. You brought this up earlier, ownership. If the grandparent owns it, there is only one beneficiary per account. I guess theoretically, five different grandkids, maybe you want five different accounts but we would also kind of caution people that the last thing you want is to have money leftover in this account because if you can't withdraw it for qualifying educational expenses, you got a 10% penalty. So there is something to be said for thinking situationally about, hey, maybe this one account is going to fulfill what I want to have happen for more than one grandchild.
Adam Werner 16:45
That's a great point and I guess the clarification there being I think you can change the beneficiary on a 529 plan. In your scenario, multiple grandchildren, let's say they're four years apart conveniently or maybe five years apart to be convenient. But yeah, you can change a beneficiary on a 529 plan I think once every 12 months. So theoretically, one child graduates, you can change the beneficiary on that same plan to now the next grandchild going through college and it's still all within that one account and you're getting that that growth over time, without having to start multiple accounts. It's just another small thing to note with 529, that you can essentially, in perpetuity, keep changing the beneficiary and it can last forever, theoretically. If at some point you pass away and now that you can pass the ownership on to your child and now they can own this account, if there's money still for their grandchild, if you can keep passing it on now, at some point, I'm assuming it's going to get spent. But that is a nice feature that is completely different than you know, any typical retirement account or non retirement account, then you continue to change the beneficiary designation to essentially allow someone else to use those funds in any given year.
Benjamin Haas 18:11
I think the big takeaways are, think about how you want to go prioritizing helping them and that may be saving on the front end. If it is, I think that takes a broader conversation, not only with these dominoes that we're mentioning but in coordinating efforts with the parents. Let's try to be smart about who's going to own the asset, whose income it's going to be, and how that's structured leading up to that time when you know those FAFSA forms need to be filled out. But on the back end, there's certainly many ways to make these gifts and many impacts that can be done. So, if it sounds like a lot, give us a call. We've gone through it a couple times. Anything else to note?
Adam Werner 18:53
No, sir.
Benjamin Haas 18:55
All right. Once again, thank you for your time and your expertise.
Adam Werner 19:00
Likewise, thank you.
Benjamin Haas 19:17
Hey everyone, Adam and I really appreciate you tuning in. Please note that the opinions we voiced in this show are for general information only and are not intended to provide specific recommendations for any individual. To determine which strategies or investments may be most appropriate for you. Consult with your attorney, your accountant and financial advisor or tax advisor prior to making any decisions or investing. Thanks for listening!
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