"Besides the tax benefits, they're enjoying a nice, warm feeling because they're able to help out," Kelly says.
Grandparent-owned 529 accounts offer distinct advantages. Clients concerned about estate taxes can move large sums from their estate, tax-free. They can help trim college costs for their progeny. And there's security knowing that money in 529 plans can be redeemed, if necessary, often with a modest tax bill.
"We always propose 529 plans to clients who are grandparents," says Paul Dixon, senior vice president at Sovereign Investment Group in Houston. "Almost half of those clients have 529 plans. They like the idea of making the gift of education, rather than buying their grandchildren computers or some other electronic item."
FIVE IN ONE
For grandparents as well as parents, contributions to 529 plans are treated as gifts. They're subject to the annual gift-tax exclusion, which means that a client can give up to $13,000 to each beneficiary this year with no gift-tax consequences. Kelly says his clients with the four grandchildren plan to donate $13,000 a year to each one. The exclusion will rise to $14,000 in 2013. (Exemption from state taxes varies.)
That means they'll remove $52,000 from their taxable estate in 2012, free of gift tax, with four 529 contributions. If both spouses contribute that same amount, they can give $104,000.
That's not even the maximum couples can give. Each person can contribute up to five years' worth of gift-tax exclusion to a 529 plan, Dixon says. "It can be a huge tool for estate-tax planning, and it will become more useful if the estate-tax exemption is reduced, as now scheduled," he says.
In a unique tax break for 529 plans, anyone can donate up to $70,000 for each 529 beneficiary in 2013, while married couples can bestow up to $140,000. Form 709, a gift-tax return, must be filed, Dixon says, because large gifts effectively use five years' worth of gift-tax exclusions.
Reducing taxable estates might not be a prime concern now, with a $5.12 million federal estate-tax exemption. More clients, though, will likely pay attention if the exemption reverts to $1 million unless Congress acts on this issue.
Even with this year's estate-tax exemption, some clients are using the accelerated exemption. The Hartford reports a significant number of large 529 contributions - those ranging from $65,000 to $130,000 - which the company attributes to people attempting to maximize the five-year allowance for these plans. John Diehl, senior vice president of strategic markets at the Hartford, says it's likely that many of these five-year contributions come from grandparents because they're most likely to have accumulated enough wealth and to be concerned with estate-tax planning.
Taking five years of gift-tax exclusion up front won't automatically remove $70,000 from a client's taxable estate. "If someone dies within five years," says Kelly, "a pro rata portion of the gift will be returned to his or her taxable estate. However, the growth of those assets won't be returned, so it can make sense to make a larger gift at one time."
FREE OF THE FORMULA
Even if grandparents are wealthy enough to have estate-tax concerns, there's certainly no guarantee that their children - the parents of the students - have immense income or net worth. Financial aid may be needed to help make college affordable for grandchildren, and a grandparent-owned 529 plan can bolster that assistance.
Consider a family in which the father accumulates $100,000 in a 529 account for his daughter. When the student fills out her Free Application for Federal Student Aid form, up to 5.64% of her parents' assets will be included in her family's expected contribution. Holding the 529 plan in her father's name can increase the family's expected outlay by $5,640 and thus reduce financial aid by that much.
If the student's grandmother is the person who owns that $100,000 529 plan, those assets aren't included in the FAFSA calculation. The girl could qualify for $5,640 more in financial aid.
"Advisors should be cautious about discussing the role of a grandparent-owned 529 account in financial aid planning," Diehl says. "Some people say that such accounts have no ramifications for financial aid. That's true for the asset itself - it's not on the FAFSA. However, when distributions come out of the 529 plan to pay for college, they become income for the student."
If the student's grandmother uses $20,000 from her 529 account this year to pay for the grandchild's education, the distribution from that grandparent-owned 529 plan will be considered the girl's income. (The same is true for a distribution from any 529 plan owned by a third party and not reported as an asset on the FAFSA form.) It will be reported on the next year's FAFSA form as student income, which reduces financial aid eligibility by nearly 50%, or $10,000 in this case.
