Should You Give a 529 College Savings Plan as a Gift?

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It may not have the "wow" factor of a video game or new bike. But for anyone giving a holiday gift to their kids or grandkids, contributing to a 529 college savings plan can provide lasting value.

By adding to their college savings, you can reduce the amount your child or grandchild may have to borrow later. And with a 529, that money will grow tax-free, if the money is used for qualified college expenses, which helps build savings faster. Plus, in many states, you also get a tax break on your contributions.

Despite these benefits, many families aren’t taking advantage of 529 plans. According to a recent survey by Sallie Mae, the college financing company, only 41 percent of parents saving for college were aware of these plans. Among parents saving for college, 30 percent were using a 529, while the rest relied on general savings accounts, checking accounts, and investment accounts, among other options.

Before you make a gift to a 529, however, it’s important to consider how the college savings plan is set up.

“The ownership of the 529 plan can have a big impact on financial aid, as well as taxes,” says Mark Kantrowitz, a financial aid expert and publisher of savingforcollege.com, which provides information on saving and paying for college.

For grandparents or other relatives, it's often better to contribute to a parent-owned 529 rather than opening your own and naming the child as beneficiary. Before you make your gift, here’s what you need to know.

The Basics of 529s

Like a Roth IRA, a 529 college savings plan lets you stash away after-tax dollars that grow tax-free. Withdrawals are also tax-free as long as the money goes toward qualified high education expenses, such as tuition, room and board. In 34 states, plus the District of Columbia, you can also get a tax break for your contributions. Under the new tax law, you can use 529 money for K-12 expenses, although not all states provide a break.

Nearly every state offers a 529 plan, and some offer more than one version. You can invest in any state's plan if you don't like your own, perhaps because it's too costly. (You can research low-cost plans using the savingforcollege.com fee study tool.) 

With all these plans, you choose from a menu of options that typically include age-based portfolios—that is, a mix of assets that automatically shift to become more conservative as the child nears college—as well as mutual funds and bank savings accounts.

The total amount you can contribute to a 529 varies by state, but the limits generally range from $300,000 to $500,000.

Fees can also vary, but the lowest-cost plans tend to be those that let you sign up directly through a state 529 plan website rather than going through a financial adviser. And they generally offer inexpensive index funds, which may charge only 0.20 percent or less. You can research the different plan options at savingforcollege.com.

If the child does not go to college, you can switch the beneficiary of the account to another relative, or the money can be withdrawn. You may also have the option of making yourself a beneficiary, depending on plan rules, assuming you want to further your education. Money withdrawn for nonqualified purposes will be taxed, and you'll pay a 10 percent penalty on earnings growth. 

How 529s Affect Financial Aid

For students who are counting on need-based federal financial aid, the impact of saving in a parent-owned 529 generally has a minimal impact on your child's ability to qualify for financial aid,

But that's not the case when for 529s owned by grandparents or other third parties, says Roger Young, senior financial planner at T. Rowe Price. Although assets in these accounts are ignored by federal aid formulas, withdrawals are treated as untaxed student income and assessed by as much as 50 percent.

For those who have already set up third-party-owned accounts, you can consider rolling over that money to a parent-owned 529. Check your plan's rules first. Some may not allow it or have so-called recapture policies that require you to pay back tax benefits if the money is rolled to another state’s plan, says Kantrowitz. 

Another option would be to hold off on withdrawals until the last two years of college, when the financial aid application is no longer a concern. (The FAFSA aid formula is based on a snapshot of family's finances from the prior two years). 

Gift Taxes and 529s

Putting money in a 529 plan has a special federal tax advantage. You immediately reduce the size of your estate by the amount you give, but you can treat the gift as being contributed over five years. That way, you can minimize the risk of exceeding the annual gift tax limit—$15,000 per individual in both 2018 and 2019; $30,000 for a couple who both donate. For example, a single grandparent can gift up to $75,000, while a pair of grandparents can gift up to $150,000.

Check Out 529 Giving Options

There are a growing number of ways to contribute to a family member's 529. You can ask the owner for the account number and send a check. But some 529 plan providers, including Fidelity and T. Rowe Price, have websites that let friends and family members contribute online directly to those plans. Account owners must first set up this option and inform family members of the link.

Account owners can also register for 529 gifts at Giftofcollege.com or Ugift, which work with most plan providers. At Ugift, account owners will receive a code that must be shared with the gift giver to direct the funds. GiftofCollege, which provides gift cards, also allows families to register for help paying off student loans. (GiftofCollege levies a 5 percent fee, up to $15, on the amounts gifted; there is no fee for account owners or gift givers at Ugift.)

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