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Why Grandparents Should Like 529 Savings Plans

Last update on: Jun 23 2020
529 savings plans

Grandparents are contributing more to their grandkids’ educations than in the past, and the best way to do this is through a section 529 college savings plan. Even when it isn’t clear a grandchild will attend college, 529 savings plans are good estate and financial planning tools to implement.

A number of factors cause grandparents to help finance their grandchildren’s education. Primary reasons are that the grandchildren need the help and the grandparents have the resources. Funding higher education also establishes a legacy that can be enduring, emphasizes the value of education to youngsters, and can make a family more appreciative and cohesive.

The 529 savings plans have many benefits, but surveys show many grandparents don’t realize all the benefits of the plans. If more realized the benefits, there would be greater use of 529 savings plans.

Let’s start by distinguishing 529 savings plans from 529 prepaid plans. The prepaid plans were the first 529 plans. In these plans, anyone can open an account on behalf of a youngster and make deposits to it. Under the savings plans, you pay in a certain amount (determined by the plan), and the child is guaranteed to have four years of tuition and fees fully prepaid at a public college in the state where the account is sponsored. Prepayment protects you from higher-than-expected tuition inflation and poor investment returns. But you’re at a disadvantage if tuition increases lower than projections or you could have earned higher returns than estimated by the plan. Also, a prepaid 529 plan lacks flexibility. If the grandchild wants to attend a private school or a public school in another state, you might not receive the full benefit of your investment.

A 529 savings plan has many more advantages. You deposit either a lump sum or a series of payments in a 529 savings account for a specific child or grandchild. You open a separate account for each youngster you wish to benefit. The deposits you make in the account qualify for the annual gift tax exemption, which is $14,000 per person in 2014. You and your spouse jointly can give $28,000 annually to each child free of gift taxes. In addition, 529 savings plans have a special rule that allows you to make five years of tax-free gifts in one year. You can deposit up to $70,000 in one year for each youngster without worrying about gift taxes or reducing your lifetime gift tax exclusion.

Your deposit is invested. Most plans offer a range of options. You can invest in a diversified, managed fund that has its allocation change over time based on the child’s age, much like a target date fund. The younger the child, the greater the amount invested in stocks. Most plans also let you choose from a limited menu of mutual funds or similar vehicles, and some are introducing ETFs to the menu.

Unlike the prepaid plans, in a 529 savings plan you have only the account balance to pay tuition and fees. If it isn’t enough to pay for four years or more of higher education, the money has to come from other sources. That probably works well for most grandparents, since the latest surveys I’ve seen grandparents generally plan to help with about half of college costs and expect the parents or the grandkids to come up with the rest.

Here are the trade offs between the two types of plans. With the prepaid plan you are giving up control and the potential for more favorable financial outcomes. With the savings plan you are taking on market risk and tuition inflation risk.

The investment returns of the 529 savings account compound tax-deferred. Also, distributions from the account are tax free when used to pay for qualified education expenses.

529 plans offer several benefits to grandparents or other contributors to the accounts that make them better than the other college savings and estate planning options.

While the grandchild or other youngster is the beneficiary of the account, you still are the owner and control the account. If you need the money back or simply change your mind, you can have the money returned without a tax penalty. There might be a penalty of up to 10% of accumulated earnings for closing the account.

You also can change the beneficiary of the account for any reason. If a grandchild decides not to go to college, passes away, or you have a falling out, you can name another grandchild or any other person as beneficiary. But to avoid penalties the new beneficiary must be in the same family as the original beneficiary, and other restrictions might apply.

You also can change the investments, within the limits set by the plan you joined.

Though the money can be returned to you and you can change the beneficiary, the account balance isn’t included in your estate as long as it is in the 529 account or distributed to the beneficiary. This is very different from trusts. If you put money in a trust for a grandchild, it is included in your estate unless you give up the right to have the money returned to you and your ability to revoke or change the trust.

There is no federal income tax deduction for contributions made to a 529 savings plan, but many states provide full or limited deductions to residents of their states who contribute to plans they sponsor. A few states allow deductions against their income taxes for contributions made to 529 savings plans of any state.

Though your state likely sponsors a 529 savings plan, you aren’t required to use it. Most states allow residents of any state to enroll in and contribute to their plans, and almost every state has at least one 529 savings plan. The money in the 529 plan can be used to pay qualified education expenses at any accredited college and university in the U.S. and abroad. Qualified education expenses include tuitions, fees, books, supplies and equipment required for attendance or enrollment, certain room and board costs, and some special needs supplies.

Some states allow money to stay in the 529 savings plan for a long time. Others require the accounts to be depleted by the time the original beneficiary reaches a certain age, usually 25 or 30.

Another little-known benefit of the plans is that if the account is not exhausted by the beneficiary, the contributor (you) can use the funds tax free for your own education purposes.

Surveys show that lack of knowledge about these benefits keep more grandparents from using the plans.

Anyone can contribute to a 529 savings plan account. Suppose you open a 529 savings plan account naming a grandchild as the beneficiary. You tell the parents you’ll plan to pay up to half of the cost of higher education and make a contribution to the account. The parents can make contributions to the same account. That simplifies college savings and account management. You’ll remain in control of the account. Note that in some states the deduction for contributions to a 529 savings account is available only to the owner of the account, not to other contributors, and most states allow the tax deductions only for contributions made to plans sponsored by the state.

Most states offer a 529 savings plan, and most offer more than one plan. Investment options, expenses, and other terms vary greatly. Many states have one or more plans in which one financial services firm, such as a mutual fund company, offers all the investment options and other plans in which the state selects the investment options and the asset allocation.

The 529 savings plan is the best way to help most grandchildren. It is better than custodial accounts and, in many cases, is better than trusts.

You should first determine if your state of residence offers tax deductions for contributions you would make to a 529 savings plan sponsored by the state. If it does, select the best plan among those offered by the state and contribute an amount up to the deduction limit. If you are able and willing to provide additional contributions for the beneficiary, find the most desirable plan nationwide and put the additional money in an account in that plan. has a good selection of materials on 529 savings plans. It offers Morningstar’s ratings of 529 savings plans, a screener to locate desirable plans, and details of the plans offered by each state. Some of the information is available only to premium members of the web site. Details of the tax rules are in free IRS Publication 970, available on the IRS web site at



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