If you’re a grandparent eager to help your grandchild earn a higher education, you want your money to go as far as possible.

But with the tricky relationship between 529 college savings plans and student aid—assuming your grandchild needs federal aid—what’s the smartest way to proceed?

The Ownership Conundrum

Grandparents have two choices when it comes to 529s: contribute to an existing parent-owned 529 or open a 529 account of their own.

Choosing one over the other boils down to preferences—and personal objectives.

The Parent-Owned 529

Grandparents who choose to contribute directly to a parent-owned 529 can in some cases receive a state tax deduction or credit in 34 states, including Oregon.

By gifting money to the parent-owned 529, grandparents also benefit in that they do not have to manage an account.

More importantly, they can support their grandchild without directly affecting financial aid eligibility.

The Grandparent-Owned 529

Grandparents who prefer to open a 529 can control plan distributions, investments, and beneficiaries.

They can also reap tax benefits by reducing the size of an estate or receiving a tax credit or deduction (if the plan offers one).

There can be a downside to grandparent-owned 529s, however. Once money is withdrawn from the account and used to pay college expenses, it’s considered income to the student—and this can affect student aid.

The FAFSA Factor

Why is this?

Blame the Free Application for Federal Student Aid, or FAFSA—the most common source of government-provided financial aid in the U.S.

Applicants must report parent and student income and assets on the FAFSA application. Parent-owned 529 plans are considered assets set aside for education, reducing student aid by up to 5.64% of the asset value.

Conversely, when money is pulled from a grandparent-owned 529 to pay for college, it’s considered income to the student and also must be reported on the FAFSA.

Here’s the rub: FAFSA considers up to half of a student’s income available to pay for college. This means money disbursed from a grandparent’s 529 can reduce a grandchild’s need-based aid by a whopping 50%.

The good news is that there are ways around this.

Giving Strategies

For grandparents who prefer to own a 529 account, there are two main ways to maximize giving—and minimize impacts to financial aid.

Strategy #1: Carefully Time Ownership Transfer

For tax purposes, grandparents still contributing to a 529 should, if possible, delay transferring ownership of the 529 to the student’s parents.

The reason for this is simple: You must be the owner of the 529 to claim available state tax deductions.

Once it’s time to withdraw these funds, grandparents can transfer ownership to a parent, providing the 529 plan administrator allows this switch. Most do, but watch out for taxes and penalties, since some transfers are treated as nonqualified rollovers.

Strategy #2: Tap Into a Parent-Owned 529 First

Here’s where things get a bit tricky.

The FAFSA considers tax information from two years prior, so students should first withdraw funds from the parent-owned 529.

This is because these funds would not be counted as income that could negatively impact federal aid in the first couple years of college.

Ideally, students would then wait to take a distribution from a grandparent-owned 529 until after January 1 of their sophomore year (assuming a four-year course of study).

This ensures—given FAFSA’s two-year-prior-income rule—that the distribution will not affect a subsequent year’s FAFSA (or related student aid).

Want to Learn More?

Helping a grandchild earn a college diploma is one of the most loving and valuable gifts any grandparent can bestow.

To earn top marks for balancing giving with tax and financial aid considerations, contact Vista.

We’d be happy to discuss a strategy for gifting money to grandchildren for their all-important education based on your goals.

We wrote this post in collaboration with our summer intern, Peter Za. Read more about Peter in his recent blog post, “What Does Wealth Mean to You?”