The Right Way for Retirees to Help Pay for College

For many of my friends, retirement seems like an exotic foreign country; we know it exists, and for a couple weeks out of every year when we’re on vacation, we may even be fortunate enough to log out of our work email and pretend we are citizens of, let’s call it Retirelandia. But then, reality sets back in and we are forced to meekly exit Retirelandia’s borders, hopeful that one day we might become permanent residents.

The strange thing about Retirelandia, however, is that it spans the entire globe. Its residents are simultaneously among us, while inhabiting a completely different sphere. You may have noticed these folks—retirees—in your midst. They often seem much happier than the average person, and also less harried. They are likely to call you on a Monday morning while you’re rushing to get to work or during your rush-hour commute back home. They seem to have lost track of time permanently. It’s a strange, enviable existence these retirees lead. And if you’re like me, and your parents dwell in Retirelandia, it can be difficult to reconcile the stressed-out people you knew growing up with these jovial, light-hearted individuals.

Of course, not everyone is fortunate enough to be a retiree. There are many who don’t have the luxury of not working, even though they’ve reached a certain age (and, of course, many people decide retirement is not for them, and opt to continue working even as their friends and spouses exit the workforce). But if you have retirees in your life, whether parents or other relatives, who are able and willing to help you financially, then it makes sense to think about how they can best help you plan for your life’s most important financial goals.

Saving for College With a 529 Plan

If you are like me, one of your financial goals might be figuring out how best to save for your child’s education. Although saving for retirement is difficult for many families, some grandparents find themselves in a fortunate enough position to be able to retire comfortably and still have the financial means to help pay for their grandchild’s college education. If this is the case, grandparents should consider establishing a 529 plan, which is a tax-advantaged savings plan designed to set aside funds for future college costs. Earnings within a 529 account grow federal-tax-free and are not taxed when the money is taken out to pay for college. For grandparents looking to provide assistance for their grandchild’s college education, a 529 plan can be a fantastic savings vehicle.

One very important caveat, however, applies to grandparent-owned 529 plans with regard to financial aid. Although money held in a grandparent-owned 529 account does not have to be reported on the Free Application for Federal Student Aid (FAFSA) as an asset, it is considered untaxed income when withdrawn to help pay for college. What this means is that any money taken out of the account must be added to the student’s adjusted gross income on the FAFSA, and up to 50% of that amount will be added to the expected family contribution (EFC) amount used to determine financial aid eligibility for the grandchild. The higher the EFC, the lower the amount of financial aid a university will provide.

Ways to Avoid the EFC Issue

To get around this issue, grandparents have two options. First, they can wait to withdraw funds from their 529 account until their grandchild’s junior year of college. This is due to the fact that the Obama administration enacted an executive order in 2015 that adopted new "prior-prior year" rules for financial aid. Under these new rules, which go in effect for the 2017-2018 school year, the FAFSA will use income not from the prior tax year but from the tax year two years prior. Waiting until the last two years of a grandchild’s college education to distribute money from a grandparent-owned 529 plan will ensure that EFC calculations do not adversely affect financial aid. The second and less complicated way grandparents can avoid inadvertently fouling up their grandchild’s financial aid, is to transfer their 529 account ownership to their grandchild’s parents. But it is important to note that a parent-owned 529 plan is treated as an asset for financial aid purposes and is counted up to 5.64% as part of the EFC calculation. Distributions from a parent-owned 529 plan, however, are not counted as income for FAFSA purposes. (For related reading, see: How 529 Plans Impact Financial Aid.)

So what does this mean? In essence, if you are in a fortunate enough position where a grandparent is willing to help contribute to your child’s college education, it is ideal for your child to wait until the final two years of college to use the funds accumulated in their grandparent’s 529 account. Parents, you should use the funds you have managed to save in your own 529 account to fund your child’s first two years of college, since spending down this money early is important, as those funds are counted as an asset for financial aid purposes and their depletion could improve eligibility for financial aid in the future. By depleting your 529 account first and decreasing the EFC calculation for your child, it is likely your child will get more financial aid, and grandparents will have to use less of the money they’ve accumulated in their 529 plan to help pay for the final two years of college.

The next time you’re discussing funding your child’s education with a retiree in your life, get clarity on how much they are willing to contribute, and don’t assume that by giving you money to place in your parent-owned 529 plan they are helping you out in the most advantageous way. Thoughtfully considering the timing of distributions from separately owned 529 plans can make a big difference in the amount of financial aid your child receives, and ultimately, in what college ends up costing.

(For related reading, see: Tax-Smart Ways to Help Your Kids/Grandkids Pay for College.)

 

The fees, expenses, and features of 529 plans can vary from state to state. 529 plans involve investment risk, including the possible loss of funds. There is no guarantee that a college-funding goal will be met. In order to be federally tax-free, earnings must be used to pay for qualified higher education expenses. The earnings portion of a nonqualified withdrawal will be subject to ordinary income tax at the recipient’s marginal rate and subject to a 10-percent penalty. By investing in a plan outside your state of residence, you may lose any state tax benefits. 529 plans are subject to enrollment, maintenance, and administration/management fees and expenses.