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Money September 2014

Dollar Sense

Help the Grandkids with College, Rake in Tax Benefits for Yourself

By Teresa Ambord

Grandparents who list themselves as the owners of the account may do so because they fear the grandchild’s parents will withdraw the money and spend it for other purposes. But if there is a need for financial aid, this can work against the recipient.

Nearly half of all grandparents plan to help their grandkids with college costs, according to a 2014 Fidelity Investments study. And more than one-third of those grandparents expect to give at least $50,000 towards those funds. If you’re in that group, you may as well contribute in a way that gives you some tax breaks and/or enhances your estate planning.

You’ve probably heard of a 529 plan. It’s a state college saving plans with significant tax advantages. Money which you place in this account grows tax-deferred, and as long as the account withdrawals are spent for qualified higher education costs they end up being tax-free. (See the sidebar for the IRS’s list of what is a qualified expense.)

What happens if the money is not spent for higher education expenses? The amount spent inappropriately is added to your gross income and you will likely also pay a tax penalty of 10%, so it’s in your best interest to stay involved.


The Tax and Estate Benefits to You

Generally an individual – like a grandparent – is subject to a limit on monetary gifts, of $14,000 per year to one individual, in this case, a grandchild. For a married couple, the limit is effectively doubled, to $28,000. That’s a great way to reduce your taxable estate. But if you have grandkids headed for college, a 529 plan is a much better idea. Under the 529 regulations, you can front-load your contributions by putting in up to five years’ worth of gifts at one time. That’s 5 times $14,000 for an individual ($70,000) or 5 times $28,000 for a married couple ($140,000), for each grandchild.

You can see this cuts a large bite out of your taxable estate and gets the money into a fund where it has time to grow, tax-deferred, for the benefit of the grandkids. However, if you front-load, you can’t make more contributions for another four years.

Another benefit, if you are at an age where you must take annual required minimum distributions from your IRAs, you can use those required distributions to fill up your 529 plan.


State Tax Deductions

Depending on the state you live in, there may also be a state tax deduction for at least part of your 529 contribution. Most states and the District of Columbia allow a deduction. According to Money Magazine, New York, for example, allows a state tax deduction of $5,000 per year or $10,000 per married couple.

Four states allow the full amount of the contribution as a deduction: Colorado, New Mexico, South Carolina, and West Virginia. To find out what your state allows, go to, and arrow down till you see “jump to,” then click on federal and state income tax impact.

You should know, while a plan is offered by one state, this doesn’t mean the child has to attend college in that state. Some states only allow residents, or offer better tax benefits to residents. It makes sense to look at several state programs with your financial planner, to find one that offers the investment choices you desire.


Who Should Own the Account?

Grandparents who list themselves as the owners of the account may do so because they fear the grandchild’s parents will withdraw the money and spend it for other purposes. But if there is a need for financial aid, this can work against the recipient. Money in a 529 plan that is owned by someone other than the child or the child’s parents is deemed to be “untaxed income” to the beneficiary of the account. That can reduce eligibility for need-based financial aid. So it’s important to think through the consequences before deciding whose name should go on the account. If you already have a 529 plan established and wish to change the account owner, you should be able to do that by filling out a form provided by the plan.

You might set up your plan as custodial, where the student is the account owner and beneficiary. If the student is a minor, the grandparents can serve as the custodian until the student reaches the age of majority. Grandparents are then able to control distributions.

Suppose you set up a 529 plan for your oldest grandson, and he later decides not to go to college. Or perhaps he wins a full-boat scholarship and does not need the funds. Generally, you can switch the beneficiary to another member of the family without tax consequences.


What if None of Your Grandkids End Up Going to College?

What happens to the money you’ve socked away? If you wish, you can change the beneficiary to yourself, and enroll in some college courses. Or you can simply liquidate the account and take the money. As mentioned earlier, there will be tax consequences if the money is not spent for education. Let’s say you have put $25,000 into an account for your granddaughter, who later runs off to backpack across Europe instead of going to college. You can cash in the account and spend it as you wish, but you’ll need to include the $25,000 in your miscellaneous income on your tax return, and pay a 10 percent penalty tax on the funds.


How the IRS Knows Your 529 Business (Don’t They Always?)

When a withdrawal is taken from a 529 account, the plan issues a Form 1099-Q, Payments from Qualified Education Programs, by February of the following year.

The 1099-Q will be issued to the person who took the withdrawals – either the account owner or the account beneficiary – and that person’s Social Security number will appear on it. Some experts recommend that you, the account owner, should have withdrawal checks made out in the name of the beneficiary. Then have the beneficiary endorse the check back to you, so you can supervise the paying of the bills. This way you can control the spending and ensure it is done properly, which is especially important if your Social Security number is going to be associated with the withdrawals.

Of course, the IRS also gets a copy of Form 1099-Q, so the government knows withdrawals were taken and who the recipient was. Be sure to keep excellent records of all expenses paid with this money.


Get Answers

It’s best to sit down with your financial planner to get your college funding questions answered. But you may also find answers by going to And here’s a tip from financial guru Suze Orman: by logging onto you may be able to find a 529 plan with lower fees.


What Expenses Can Be Paid with 529 Funds?

I’ve seen experts disagree on this. So here’s the scoop straight from the mouth of the IRS:
Earnings are not subject to federal tax and generally not subject to state tax when used for the qualified education expenses of the designated beneficiary, such as tuition, fees, books, as well as
room and board.

Also, qualified purchases now include: computer technology, related equipment and/or related services such as Internet access. The technology, equipment or services qualify if they are used by the beneficiary of the plan and the beneficiary's family during any of the years the beneficiary is enrolled at an eligible educational institution.

“Computer technology” means any computer and related peripheral equipment. Related peripheral equipment is defined as any auxiliary machine (whether online or off-line) which is designed to be placed under the control of the central processing unit of a computer, such as a printer. This does not include equipment of a kind used primarily for amusement or entertainment. “Computer technology” also includes computer software used for educational purposes.


Teresa Ambord is a former accountant and Enrolled Agent with the IRS. Now she writes full time from her home, mostly for business, and about family when the inspiration strikes.

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