Who should own your kid's 529?

There is no single way to save for college which is best for everybody.  The 529 plan, a recent innovation, may be one of the best, but it creates as many questions as answers.  An earlier generation of savers used UTMA and UGMA accounts to save in their kids names in order to save in income taxes along the way, but UTMA and UGMA accounts lost much of their value with some recent tax updates, and they've always suffered certain defects with respect to what happens when someone else - the child in this case - actually ends up owning the assets.

Before we dive into 529 ownership, let's address just who we are talking about here - mainly this is for parents and grandparents, though most of the caveats which apply to grandparents apply to others such as aunts or uncles when considering 529 plan ownership.

And secondly, before just assuming that the best way to save for college is a 529, please be sure to explore (a) whether saving for college right now is actually the best thing to do and (b) whether there may be other funding mechanisms for college when the time comes.  With respect to these last couple of caveats, bear in mind that if one isn't already maxing out various retirement savings opportunities - especially Roth IRAs, self-employment retirement plans, and particularly any employer-based plan where there's an employer-provided match - please consider carefully whether you should be saving for retirement first.

Now, that all said, supposing you've come to the conclusion that a 529 is a great way to save, the biggest question which likely follows is whether you think you'll have any chance at getting financial aid.  The financial aid formulas naturally try to make aid available to those who are of lesser means - if you're rich, you shouldn't need the help, right?  Well, one person's "rich" is another person's "just getting by in the middle class" so without making any value judgements as to whether someone with enough assets to consider a 529 should or should not be getting financial aid, we should certainly know what the impact of a 529 is on financial aid.

So here's the short story: the current federal financial aid guidelines are such that a 529 which is owned by a parent is considered an asset of the parent, not the child.  Up to 5.64% of the parents' assets are considered to be available fas the family's expected contribution.  If the 529 were an asset of the child, the expected contribution is much higher - one almost never wants the 529 to belong to the child.  And if the 529 is owned by the grandparent, with the child as the beneficiary, it is not considered an asset of the child nor of the parent nor of the family, so the amount of money in the 529 is not considered at all when they compute the expected family contribution.

So what's the downside to having the 529 owned by the grandparent - why wouldn't you shove all the money in that way?  It's on the income side of the equation rather than on the assets side of it.  When money is spent by the grandparent's 529 on behalf of the child in school, in the following year, that spending is considered income for the calculations - as if the parents had earned that much more in that year, so the following year, when they compute the family income and assets to tally up the expected family contribution and the amount of aid they'll get, it's got a huge impact.  If the family earns only $50,000, but the grandparents used $25,000 from a 529 towards the kids schooling in year 1, in year 2, they'll assume that the family's income is $75,000 now and offer less aid.  One way to minimize the impact of this is to spend down parent-owned 529 assets during the first few years of school and save the grandparent-owned 529 for the last year.

In the end, there are still some substantial benefits to having 529 assets in both parent and grandparent-owned accounts, particularly tax-free withdrawals of the growth of those assets when it's time to pay those college bills.  But you have to weigh the impact of those funds against any aid you might qualify for.

And if you're looking towards financial aid, again, make sure to think carefully about maxing out retirement savings first - retirement savings are generally not considered at all, and if you crank the assets into your retirement plans now, even if you have to stop making retirement plan contributions when your kids are actually in school (and paying tuition out of current income when the time comes), your retirement savings can keep growing for the much longer term.  College may be great, but nobody offers financial aid for retirement and you can't borrow to finance retirement, so don't think it's selfish to put your retirement savings first.

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