Saturday, February 26, 2011

Q&A Series - Tax Considerations for Establishing 529 Plans for Grandchildren

Bob, a client with young grandchildren, read our financial aid Q&A and had an additional question regarding establishing 529 plans for his grandchildren.

Q: After reading your post about assets affecting financial aid, I’m thinking about establishing 529 plans for my two wonderful grandchildren. What are the tax considerations?

I’m so glad you asked this question, Bob. Many of our readers have young grandchildren, and I can think of no greater tangible gift than assisting them with their higher education. It creates a direct connection to your grandchildren, even if you are not around when they attend college.

As I stated in my Q&A concerning assets affecting financial aid eligibility,
a relative can establish a 529 plan for a child (in the relative’s name, not the child’s). If it’s set up this way, the assets won’t factor into the child’s financial aid application at all. This is because the contributing relative – not the parents or the child – “owns” the account, with the child named as beneficiary.

If you do establish 529 plans for your grandchildren, for gift tax and generation-skipping transfer tax purposes, your contributions will be treated as gifts to the grandchildren. Accordingly, if you make other gifts to the grandchildren during the same year, you will need to keep your 529 contributions in mind.

Because your contributions would qualify for the $13,000 annual gift tax exclusion, you can make fairly large contributions without incurring the gift tax. Furthermore, you can elect to treat the contribution as made over a five calendar-year period for gift tax purposes if you make a contribution of between $13,000 and $65,000 per beneficiary. This would mean that in Bob’s case, he can contribute up to $130,000 for his two grandchildren combined, which would allow him to utilize as much as $65,000 in annual exclusions to shelter a larger contribution.

Most advantageous about this arrangement is that even though the assets leave your estate, they do not leave your control – a great benefit if you compare it to the typical gift and estate tax laws. There are very few tax laws other than those regarding 529 plans that allow you to gift out of your estate but still maintain control of the assets. Of course, if you later revoke the plan, the account value comes back into your estate and you may owe estate or income taxes. Also, with the five-year averaging election, your estate will have to include a portion of any contributions made if you don't live past the fourth year.

Bob, thanks again for your question. I know that grandparents take great pleasure in being generous to their grandchildren. These substantial gifts would not only be very thoughtful, they would also be of great benefit to your estate from a tax perspective.

We encourage our clients and readers to send us questions for our Q&A series at And as always, we hope you will keep Rollins Financial in mind when seeking professional advice on financial planning and investing.

Best regards,
Joe Rollins