"There's a workaround for those situations," says Mike Piershale, president of Piershale Financial Group in Crystal Lake, Ill. "The advisor can tell the grandparent to delay distributions from the 529 plan until no earlier than January of the student's junior year, if it's possible to wait that long. By then, the student will be done with filling out the FAFSA, so the income won't matter."
Suppose that the hypothetical students starts college in August 2013 and graduates in May 2017. Her last FAFSA form (assuming she won't attend graduate school and apply for financial aid again) would cover the 2016-17 academic year. That FAFSA form will be filed early in 2016, based on financial data from 2015. Thus, distributions from the grandmother's 529 plan to the student in 2016 and subsequent years may not affect financial aid.
Regardless of whether grandparents have estate-tax concerns or hopes of helping to obtain financial aid, putting money into a grandchild's 529 account may be an appealing option. "Unemployment is high and a college background can have a substantial impact on future earnings,'' Diehl says. "If grandparents want to help grandchildren with college funding, then a 529 plan is the best vehicle," he says.
Many grandparents think about college costs, Kelly says. "If a client's retirement strategy is clear, we ask about secondary objectives," he says. "Grandchildren's education is usually not first on the list, but it's generally in the top five."
As with any 529 plan, the account owner can withdraw the money. Income tax and a 10% penalty will be due, but only on the earnings portion of the withdrawal. So grandparents can provide generous support to their grandchildren's future while knowing they can reclaim their own money if the school of hard knocks deals them some unexpected tough lessons.
Correction: An earlier version of this story said that individuals can donate up to $65,000 for each 529 beneficiary in 2013 and take advantage of the gift-tax exclusion. The correct number for 2013 is $70,000 for each 529 beneficiary.
Donald Jay Korn is a Financial Planning contributing writer in New York. He also writes regularly forOn Wall Street.