Now that my kids are out of college, it’s time to start thinking about trying to help out my (future) grandchildren’s education.  Who knows how expensive that’s going to be in twenty-plus years?  It’s actually fairly common that grandparents want to help with college expenses for their grandchildren.  And most grandparents want to do so in a way that won’t affect their grandchild’s financial aid eligibility.

One of the most common ways that parents and grandparents help is through use of a 529 Plan.  A 529 Plan is a special type of tax‑deferred account that has both an owner and a beneficiary.  In most cases, it’s beneficial that the grandparent be the owner of the account.  The beneficiary is the student incurring college expenses.

There are a number of advantages of a 529 Plan, especially over a regular savings plan or a custodial plan.  First, contributions to a 529 Plan are removed from a grandparent’s taxable estate for both federal and New York Estate Tax purposes.  This is also true in a custodial account, but in that case the funds can be used at any time for any purpose, so long as it’s for the child or grandchild’s benefit.

Second, the contributions grow free of any income taxes.  Withdrawals from the plan are free of tax so long as used for qualified higher education expenses.  And if one child doesn’t need it, the owner (usually the grandparent in this case) can change the beneficiary on the account to another family member of the original beneficiary.

Many of the questions about 529 Plans that clients have asked me revolve around their effect on student aid.  The good news is that so long as the grandparent (not the parent) of the student is the owner, the 529 Plan does not count as an asset for determining financial aid.  However, the bad news is that any distributions from the grandparent‑owned plan do count as income for student aid purposes.

A fairly straightforward strategy that can mitigate this income effect is as follows: by January 1 of the student’s junior year, the student will have filed his last FAFSA.  This means that distributions from a grandparent‑owned 529 Plan after this date will not affect financial aid.  If the student’s parents have saved anything for the student’s college, the strategy here is to use their savings for the first 2.5 years of college, and then use the grandparent‑owned 529 Plan to pay for the final 1.5 years.  If you have to use the grandparent 529 Plan earlier, then obviously you should do so, but it will still minimize the overall effect it will have on the student’s financial aid.