How to Build College Savings For Your Grandchildren

  • By KELY GREENE

  • I would like to start saving for my grandchildren's college fund, but do not want the parents to have access to it or not have it (hopefully) affect the financial-aid eligibility of the children. What are some ways to achieve this, and with what type of investment?
    Gerald Astorino
    Manchester, N.H.


    You could open a "529" college-savings plan and name a grandchild as the beneficiary -- there's no requirement that the beneficiary or his or her parents know about it. Earnings and withdrawals from 529 accounts are exempt from federal taxes when you use them for a wide range of higher-education expenses, and legislation approved earlier this year made those tax breaks permanent.

    There's another perk for grandparents: The money you put into a 529 plan is no longer considered part of your estate, even though you still get to decide how to invest it. A single grandparent could contribute up to $14,000 a year for each child or grandchild without incurring gift taxes, or you could contribute up to $70,000 in one fell swoop, using up five years' worth of gift-tax exemptions at once. And a set of grandparents giving together could double those contribution amounts.

    Unfortunately, the impact that a 529 plan would have on your grandchildren's financial-aid eligibility is harder to determine. Your grandchildren wouldn't have to report 529 savings on the standardized federal financial-aid form, says Joe Hurley, founder of http://www.savingforcollege.com, an independent Web site that provides information about 529 plans. "However, when the 529 funds are actually used to pay for the student's expenses, they may or may not be considered in determining eligibility based on the policies of the [individual] college."

    So far, the only clear guidance from the government on the subject is that tax-free distributions from 529 accounts aren't reported as income -- but it's unclear whether that guidance applies to accounts owned by grandparents, Mr. Hurley adds.

    Still, tax-free growth, investment control and the estate-planning advantages may outweigh that uncertainty, particularly if your children's own income already would make much financial aid unlikely for your grandchildren.

    How do you go about choosing from dozens of 529 plans offered in 50 states and Washington, D.C.? Many states offer tax breaks for in-state investors (listed at www.collegesavings.org). Morningstar Inc., a Chicago investment-research firm, also has 529 data at http://www.morningstar.com (under the "personal finance" tab).

    A number of states waive account-maintenance fees for residents, but charge out-of-staters $20 to $25 a year. And some states allow only residents to invest directly; people who live elsewhere would have to go through a broker and pay any commissions or fees that they charge, Mr. Hurley says.