Financial Literacy

Your 529 Questions… Answered!

For all the drama around Iran and the threat of war, the markets have been remarkably stable so far in 2020. So let’s use this lull to return to a topic that spurred a lot of interesting questions from our readers: grandparents and 529s.

What are the consequences of letting a plan “coast” to the next generation or further? Is this idea a valid estate planning tool for future generations? – Rebecca L.

Since a 529 must be used for educational expenses, what happens if the grandchild doesn’t continue an educational path?

Wouldn’t funding a Roth IRA in your own name be a better choice? Then you have the option of keeping the money for yourself tax-free if your grandchild does not go to college.

I believe you have to pay taxes on a 529 if it is not used for education and you withdraw it. – Bruce J.

To help answer these questions, I reached out to Tara Falcone, a certified financial analyst (CFA) and certified financial planner (CFP) and the founder of ReisUP, a site dedicated to financial literacy.

First and foremost, “Make sure you’re set for retirement before you even start thinking about contributing to grandchildren’s education,” Falcone says. “Don’t sacrifice your own well-being. There are loans for college, but not retirement.”

A second caveat is that everyone’s situation is different. There is no one-size-fits-all when it comes to financial planning. How you want to help your grandkids and other heirs is entirely up to you.

Third, the answers to most of these questions depend on the amount of wealth involved.

For the purposes of this article, I’ll assume you don’t have the kind of wealth that might trigger a lifetime gift exemption tax – $11.4 million per individual or $22.8 million per couple.

If you have anything approaching that level of wealth, you should definitely be working with an estate planning attorney who has detailed knowledge of your situation.

For the rest of us, a 529 plan “can be an interesting way to pass wealth down to future generations,” Falcone says.

Building Wealth for Decades

For starters, a grandparent can start a 529 college savings fund by giving up to five years’ worth of contributions – the maximum is $75,000 – in one shot. That limit is doubled for couples.

“Front-loading” a 529 when a grandchild is relatively young gives the funds more time to benefit from compounding interest. Often called the most powerful force in the universe, compounding is the repeated addition of interest to principal.

As this “interest on interest” grows over time, significant wealth is built. (Just ask Warren Buffett.)

Also, the $75,000 max contribution to a 529 compares very favorably with the $6,000 maximum annual limit to a Roth IRA.

This is a good option for grandparents who have “a significant amount of wealth to gift… without incurring gift taxes,” Falcone says.

Dodging Hurdles From Taxes and Financial Aid

The annual limit on gifts is $15,000, or $30,000 per couple. And that becomes relevant only if you hit the lifetime gift limit of $11.4 million per individual or $22.8 million per couple.

In short, an individual can move up to $75,000 per grandchild from their taxable estate every five years without incurring estate taxes.

Yes, that’s right: Funds in a 529 are not subject to estate taxes. Although you, as the account owner, control the funds, they are considered to be property of the beneficiary.

That’s why it’s best to save 529 assets from a grandparent to pay for the student’s junior or senior year if they’re applying for financial aid.

Because federal financial aid is based on income from the “prior prior year” – i.e., two years before the application is made – those assets will not be considered for junior year calculations, and senior year is not factored into future federal student aid.

Your grandchild might have to pay taxes once the funds are distributed, Falcone adds, but it depends on their overall income.

A Flexible Option for Encouraging Learning

So what happens if 529 funds aren’t used for “qualified” educational purposes?

The bad news: If the original beneficiary doesn’t want or need the 529 funds, they are subject to ordinary federal and state income taxes. With some exceptions, there’s also an additional 10% federal tax.

The good news: If the 529 funds aren’t used for educational purposes, they can be transferred to another qualified tuition program to benefit other family members. And the IRS has a broad definition of what a “qualified family member” is, Falcone notes.

Qualified family members include the beneficiary’s siblings, parents, children, nieces or nephews, as well as in-laws.

As with many things in life, there’s more than one way to help pay for your grandkids’ education. You can pay a student’s tuition directly to the university. Or you could wait for the student to graduate and then pay off their student loans.

As with the 529s, each of those options has its own wrinkles and ramifications, including potential taxes.

So do your homework and consult with a tax expert first. That way, you and your heirs can maximize the benefits of your good intentions.

Good investing,



Aaron is an expert writer and researcher who formerly served as editor-in-chief at Yahoo Finance, digital editor of Fortune, and executive editor and San Francisco bureau chief of TheStreet. You may have also seen him as a guest on CNBC, CBS This Morning, Fox Business, ABC News and other outlets.

A prolific writer and commentator, Aaron is the former host of Yahoo Finance’s video program The Daily Ticker. He has also hosted podcasts for Fortune (Fortune Unfiltered) and TheStreet (The Real Story). His latest on-air passion project, Seeking Alpha’s highly rated Alpha Trader podcast, features top Wall Street experts dissecting the market’s latest news and previewing significant upcoming events. He also regularly provides analysis for the free e-letter Wealthy Retirement, which we will be republishing here on Investment U.

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