As you're no doubt aware, September 7, 2008 is National Grandparents Day. The commemoration was officially proclaimed 35 years ago, in order to motivate younger family members to honor and cherish their elderly “Nannas” and “Goompas.” Or at least pick up the phone to call once in a while.
So it might not seem to be in the proper spirit of the holiday to use the occasion to discuss 529 college savings plans with clients who are grandparents. Although adult children and young grandchildren will certainly benefit if Grandpa socks some money away for the little tykes' college costs, there are also plenty of advantages for the grayest generation.
Here's why grandparents should love 529 plans almost as much as they adore the children who will one day use the account proceeds.
Of course, the primary motivation for depositing money into 529 plans should be to pay for future college expenses. But ignoring the many tax advantages offered by 529s would be discourteous to the legislators who created the breaks in the first place.
Start with a potential state income tax deduction that many plans provide to depositors, even those who are of a generation once removed from the child beneficiary. (You can sort through an exhaustive list of each state's deductions at www.savingforcollege.com).
Then consider that the earnings on money left in 529 plans are sheltered from any taxation going forward. Not only will this reduce what seniors owe to the government each year, but it may also prevent their Social Security checks from getting taxed.
Yet the biggest tax reduction offered to grandparents by 529 plans may come only when they're not around to see it. That's because money deposited into the plans usually represents a “completed gift,” and is therefore not subject to estate taxes when the owner dies.
Considering the high degree of uncertainty surrounding the status of the estate tax rate and exempted amount, this may be the ancillary feature of 529 plans that is most attractive to even middle-net-worth grandparents, to say nothing of their wealthier peers.
529s allow depositors to get the money out of their taxable estate without actually giving up ownership of the assets. It's an especially enticing feature for those wise enough to know how uncertain the future can be.
First, the clients may need the money down the road for mundane living expenses, or unexpected, uncovered health care costs. Although withdrawals for these non-qualified expenses will subject the earnings to both taxes and a 10-percent penalty, the result may not be as onerous as you or your clients fear (see sidebar).
Then there is the problem of trying to predict just how gifted, talented and hardworking a toddler is going to be by the time she hits her late teens. If the kid ends up sowing wild oats instead of hitting the books, the grandparent can change the beneficiary of the account to another family member of the same generation with no tax implications.
Of course, all that control held by the 529 account owner does have a small downside, in that if the owner needs nursing home care, the 529 accounts may need to be liquidated before any Medicaid assistance is offered.
Even More Financial Aid
Some well-meaning grandparents may wish to skip the money middleperson and just give the funds directly to the grandchild or the grandchild's parents to save and spend for college, however the recipients choose.
That might save time and paperwork, but it could also end up costing the family a lot if they would otherwise qualify for financial aid.
Why? Because money held by the parents or by the parents for the child's benefit can be counted toward the “Expected Family Contribution” calculation made by the school's financial aid office — even if the assets are in a 529 account.
But money held in 529s owned by the grandparents for the grandchildren does not have to be disclosed on the federal financial aid form (also known as the FAFSA, and available at www.fafsa.ed.gov).
Even withdrawals from these accounts are unlikely to affect future federal aid awards to the student. However, a small number of institutions may ask about money saved by grandparents before awarding any institutional aid.
Clients of a certain age may be particularly attracted to the idea that they can set up 529 accounts for their grandchildren without divulging details to either the parents or the kids. All the depositor needs is the child's name, birth date and Social Security number.
The first two bits of data are usually committed to memory by any grandparent deserving of the name. The latter can typically be gained by a phone call to the children's parents, especially if the mom or dad understands why the information is needed.
Next month you'll find out the best way to discuss 529 accounts with current and prospective clients who are grandparents, and how to use the process to address their retirement and estate planning needs as well.
In the meantime, if a loved one of yours is a grandparent, check in on him or her while you still have the opportunity to do so.
Writer's BIO: Kevin McKinley
CFP© is Principal/Owner of McKinley Money LLC, an independent registered investment advisor. He is also the author of the book Make Your Kid a Millionaire (Simon & Schuster), and provides speaking and consulting services on family financial planning topics. You can reach him at [email protected].
MATH LESSON: TAXES AND THE 529
Some grandparents might balk at the idea of putting money in a 529, since withdrawals not used for qualified higher education expenses may be subject to taxes and penalties.
But those taxes and penalties aren't the end of the world. Say your clients put aside $100,000 into 529 accounts now, and the money grows at a hypothetical return of 7 percent per year for 10 years. It will be worth about $196,000.
If they then withdraw the entire balance for unqualified expenses and pay a total of 40 percent of the earnings in income taxes and penalties, they'll still net out about $158,000 — an annualized after-tax return of about 4.5 percent.