Nadine was overjoyed when she called to tell us the news: her daughter and son-in-law were expecting – she was going to be a grandma! While Nadine is most looking forward to spoiling her future grandson or granddaughter with playdates and lots of sweets, she also wants to make sure her grandchild can pay for college someday. Here’s how we answered Nadine’s questions:
Q: What is the best way to save for a grandchild’s education?
A: While there are many college savings options on the market, the most popular is a 529 Savings Plan due to the tax advantages – these accounts grow tax deferred and are distributed tax-free if used to pay for education at an accredited school. If your first grandchild does not use all the funds, it can be transferred to their siblings. If not used to pay for education, the funds are taxable upon distribution and incur a 10% penalty on the account’s growth.
Q: When can a 529 account be opened, and which investment option is the best?
A: A 529 account that names a child as a beneficiary can be opened as soon as that child is born. In Maryland, there are two types of plans: the College Investment Plan and the Prepaid College Trust. We generally recommend the College Investment Plan, as this option lets the account holder choose the investments, and funds can be used for tuition, room and board, books, and more. The second option is a Prepaid College Trust. For the Prepaid option, you pay a fixed amount to pay in advance for a child’s tuition credits; keep in mind that this covers tuition only.
Maryland 529 Savings Plans are managed by T. Rowe Price, and the state offers a tax break if you use their plans. Each contributor can deduct up to $2,500 of contributions on their Maryland tax return. For example, a grandmother and grandfather could deduct a total of $5,000 on their joint tax return.
Q: Should the account be opened in the grandparent’s name or the parent’s name?
A: A 529 account can be opened in the grandparent’s name or the parent’s name, but keep in mind that this will affect the grandchild’s financial aid calculation. If the 529 account is opened in the parent’s name, it counts as income for the parents on their FAFSA application. If the 529 is opened in the grandparent’s name, it counts as income to the grandchild upon distribution, which will reduce their financial aid more than if it is the parent's asset. For this reason, many grandparents gift money to a 529 account opened by the parent. But if the grandparent opens the account in their name to secure the tax deduction, one strategy is to delay fund distribution until the child’s junior year of college to avoid income inclusion.
Q: How much can a grandparent contribute to their grandchild’s 529 account?
A: While 529s do not have a total annual contribution limit counting all contributors, there are limits to how much each contributor can deposit to the account in a year. 529 contributions are considered gifts to the beneficiary. To avoid dealing with the IRS, grandparents and other contributors can each put up to $16,000 into a 529 in 2022. If you want to contribute more than $16,000 in a year (or $32,000 for a couple filing jointly), talk to your financial advisor – in some situations you can use 5-year gift contribution.
Feeling more knowledgeable after her conversation with her financial advisor, Nadine spoke with her daughter and son-in-law. Here’s their plan: after the grandchild is born, Nadine’s daughter and son-in-law will open a 529 account in their names. Nadine will give a one-time gift of $16,000 for this account. By the time her grandchild turns 18 and goes to college, this money could be worth about 4 times the initial investment – that’s the power of starting early! If you’re considering saving for your grandchild or child’s education, give your financial advisor a call. We can help walk through the specifics of your situation and help you come up with a plan.