Q: I have 529s for my grandchildren. To avoid the negative financial impact of grandparent funds on financial aid: Can I transfer the 529 funds to the parents? Will the transfer be subject to a gift tax? I live in Ohio so will the state tax deductions that I received need to be refunded to the state? Are there negative financial aspects to this approach?
A: The problem here is that 529 funds held by the student’s parents are considered at 5.64% for financial-aid calculations, while grandparent funds aren’t considered at all until the student starts withdrawing the money for educational purposes. At that point, the withdrawn money is counted as untaxed student income, which is counted at 50% when colleges calculate financial aid, says Ross Riskin, assistant professor of taxation at the American College of Financial Services. That’s why it is generally considered better for the parents, rather than the grandparents or other adults, to be the owner of a 529 held for a dependent student.
“Any 529 account holders, including grandparents, are able to transfer funds to parents without triggering a gift tax,” says James DiUlio, director of Wisconsin’s 529 program and the chairman of the College Savings Program Network. Check if your plan allows this. (Ohio’s does, he says.)
Changing the account’s owner won’t have tax consequences, but if you were to switch the beneficiary to a member of the family in a different generation—for instance, from your grandchild to your great-grandchild—that could trigger tax issues, Mr. Riskin says. Check with your tax adviser about this and about how to account for state tax benefits you have already received if you switch the account to a different owner.
Note that a change in the rules for Fafsa (Free Application for Federal Student Aid) means that grandparents could help pay for an additional year of college without hurting their grandchild’s chances for aid. With the change, colleges now look back two years to determine a family’s ability to pay for college. So, if, say, grandparents help pay during the first and second years, that counts against the family when potential aid is calculated for the third and fourth years. If, however, the grandparents help pay in the final two years, it no longer matters because the student will be finished with school after that. Thus, grandparents can now pay for a student’s third and fourth year with their 529 funds, instead of waiting until the fourth year, Mr. DiUlio says.
“If needed, an account holder could also do expenses for a preceding summer session or the second semester of the second year, if it began after the first of the year,” he says.
Q: We have I-savings bonds bought in 2001 that have more than doubled in value but are under the annual gift-tax exclusion level. Can we give them to our son to use for our grandson’s college tuition this year? What will the tax consequences be for us and for our son?
A: You can’t re-title the bonds. That’s only permitted if the original owner dies or gets divorced, Mr. Riskin says.
“With that being said, the bonds can still be redeemed and the funds could be gifted to your son to pay for your grandson’s college tuition this year; however, the interest received upon redemption would not qualify for the education-tax exclusion since the bond proceeds need to be used for qualifying education expenses incurred on behalf of the bond owner, the owner’s spouse, or a dependent for whom the bond owner can claim an exemption,” he says.
Q: I opened a 529 account for my stepson’s stepson. Years later, the couple divorced, and the boy refuses to speak to anyone from our family. He is now 20 years old and has decided not to attend college. Since I can’t get him to respond to my messages about this money that belongs to him for school, can I move the money to benefit his younger siblings?
A: Although it’s a sticky family situation, the financial picture is less complicated. You can switch beneficiaries to any relative in the original beneficiary’s family without involving him, so it’s no problem to make the account over to his siblings, Mr. DiUlio says.
“Even though completed gifts were made at the time you contributed to his 529 college savings plan account, you still have control over the account and can change the beneficiary, assuming this was not set up as a custodial 529 college-savings-plan account in which the student is the account owner and the beneficiary, which would not allow for the beneficiary change,” Mr. Riskin says.
Q: My son plans to get a plumbing apprenticeship after high school. He would work full time earning an entry-level wage, and his employer would pay for night classes at a community college for four years until he earns a journeyman license. He is our youngest child. What are our options with the funds in his 529 plan? Could room and board at our home be considered an educational expense?
A: Your son is lucky to have his employer paying his tuition.
“With those expenses covered, there are plenty of other ways your son can use his 529 funds including textbooks, software and personal computers related to instruction,” Mr. DiUlio says.
While room-and-board expenses are permitted under the 529 rules, you might have a difficult time spending 529 money on this if your son is studying at a community college, Mr. Riskin says. To have those expenses considered “qualified,” the college has to include room-and-board costs in its total cost of attendance, which many don’t; when they do include these costs, the amounts are often significantly lower than at a four-year college, he says. Check with the school your son will attend on the cost of attendance calculation, and note that he will have to be enrolled at least half-time for room and board to be a qualified 529 expense.
Q: My daughter has a music degree and is now looking into music graduate programs for a master’s. She has money remaining in her 529 plan after graduating with a bachelor's degree. Can the money be used for application fees, travel and accommodations to visit universities?
A: No, these expenses aren’t considered qualified distributions, Mr. DiUlio says. You would have to pay income taxes on the gains portion of any withdrawals, plus a 10% penalty.
You can also wait until she enrolls in graduate school to use the money.
“The best course of action would be to wait to use these funds for qualified expenses such as tuition, books and supplies associated with the program she eventually chooses,” Mr. Riskin says.
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