Changes To Use of 529 Education Savings Accounts

Grandparent Owned 529s

Historically when qualified distributions were made from grandparent owned 529 accounts those withdrawals were treated as untaxed student income on the FAFSA. This was important for those students who were using 529s to fund their college expenses but also applying for and using grants and scholarships that used the FAFSA. Student income is considered a 50% reduction in student aid qualification. For example, if you took a $10,000 distribution it would reduce the student aid by $5,000. You could get around this issue by rolling funds over to a parent owned 529 from the grandparent 529 before making distributions. However, you were only allowed to do this once per year. As you can imagine this was a pain. Under the new simplified FAFSA rules grandparent owned 529 education counts are not listed as assets or income so they will not affect the financial aid package at all.

These accounts are great estate planning tools as well as setting your grandchildren up for success by avoiding student loans. Current IRS rules allow each grandparent to contribute $16,000 each year to the 529 of each beneficiary while avoiding gift taxes. These gifts then grow tax deferred and qualified distributions are tax free. Some states even offer a tax incentive to contribute to the 529. Missouri allows a tax deduction on up to $8,000 of contributions per taxpayer each year.

Rollovers to Roth IRAs

There is pending legislation with bipartisan support that is being coined the Helping Parents Save for College bill. One of the key changes this would make is giving account owners another great option for what to do with any leftover funds in 529 accounts. Currently you have three options; leave it in the 529 account in hopes that one day it will be needed for a qualified expense, change the beneficiary to another family member who will have qualified expenses, or withdraw the funds and pay the taxes on the portion of nonqualified distributions that are taxable. This legislation would add the option to do a rollover to a Roth IRA for the same beneficiary which would give students a great head start on saving for retirement. Hopefully this is a change that we will see soon.