How to Set Up a College Savings Plan for a Grandchild

A four-year college education is expensive. Research from the College Board* says the average published yearly cost of tuition and fees for 2021-2022 at a four-year private college was $38,070, while it was $10,740 for in-state students at a four-year public school. Room and board are another charge. And if history is any guide, college is unlikely to get any less expensive over time.

If you have grandchildren and would like to help them get a good start in life, what better gift could you give than the opportunity to graduate from college with few, if any, student loans? One tax-advantaged way to help fund the cost of college is through a Section 529 plan. Here's what you need to know about setting up this type of plan for a grandchild.

What They Are, How They Work

Most Section 529 plans are state sponsored. They come in two varieties: prepaid tuition plans and college savings plans. You can set up a separate Section 529 plan for as many beneficiaries as you wish and fund each plan by investing a lump sum or by making regular contributions. You can contribute to a Section 529 plan regardless of your annual income or age. Moreover, if you don't like some of the features of your state's plan, you can participate in another state's plan.

The money in a Section 529 plan grows on a tax-deferred basis, and distributions for qualified educational expenses are free of federal income tax. (Many states offer Section 529 plan tax benefits for their residents as well.) To avoid federal gift taxes on your plan contributions, you can limit them to the gift-tax annual exclusion amount ($16,000 per beneficiary in 2022; $32,000 if you and your spouse contribute) or elect to treat a larger contribution as though the gift was spread out over five years. By contributing, you are generally also removing the gift amount from your estate for federal estate tax purposes.

Another big advantage to opening a Section 529 plan on a grandchild's behalf is that grandparent-owned Section 529 assets are not factored in to the Free Application for Federal Student Aid (FAFSA), which helps determine a student's eligibility for grants, work-study programs, and loans. However, just be aware that up to 50% of any distribution made from a nonparent-owned Section 529 plan may be counted as income on a student's future financial aid applications. (It may be possible to avoid this situation by delaying distributions from nonparent-owned accounts until the final two years of a grandchild's college career.)

It can be smart to open the account while your grandchild is still very young. By investing sooner -- and thanks to the power of compounding -- a significant sum potentially may be available to pay college expenses by the time your grandchild enters college.

In addition to Section 529 plans, there may be other options you can explore if you want to help pay for a grandchild's education. It can make sense to work with a financial professional to determine what approach is best for your circumstances.

*Trends in College Pricing 2021, The College Board.

Investing in Section 529 plans involves risk, including loss of principal. Before you invest in a Section 529 plan, request the plan's official statement and read it carefully. The official statement contains more complete information, including investment objectives, charges, expenses, and the risks of investing in a Section 529 plan, which you should carefully consider before investing. You should also consider whether your home state or your beneficiary's home state offers any state tax or other benefits that are only available for investments in such state's Section 529 plan. Section 529 plans are not guaranteed by any state or federal agency. By investing in a Section 529 plan outside of the state in which you pay taxes, you may lose the tax benefits offered by that state's plan. Withdrawals used for qualified expenses are federally tax free. Tax treatment at the state level may vary.