The opportunity to contribute to your grandchildren's education is invaluable, and 529 savings plans have unique tax features that could help you do so. A 529 plan also lets parents and grandparents retain control of the money in the account, which could be helpful if unexpected retirement expenses arise.

If you want to help someone pay for school — but keep the flexibility to use those funds if you really need them — a 529 plan might be a good choice.

What Is a 529 Savings Plan?

A 529 plan is an education savings program sponsored by a state, a state agency or an educational institution. The two primary types of 529 plans are savings plans, which grow tax-deferred and can be used for qualified education expenses, and prepaid tuition plans, which allow you to pay for tuition at designated colleges and universities in advance.

You can use the money in a 529 savings plan to pay for a number of qualifying education expenses, including costs incurred at colleges, universities and trade schools or in graduate school. Depending on the type of 529 plan you have, you might also be able to spend 529 money on tuition at elementary and secondary schools.

Tax Benefits

A 529 savings plan could provide a tax benefit that eases the burden of paying for education. Any growth in a 529 plan can be withdrawn without incurring federal income tax, so long as you use the money for qualifying education expenses. And depending on your state's rules, you might be able to claim a state income tax deduction for the contributions you make to a 529 plan. (You typically need to use your home state's 529 program to qualify for the state tax deduction.)

For grandparents, 529 plans could be a way to open savings accounts for grandchildren, and these plans offer some built-in flexibility. As the account owner, you keep control of the money, and you can take the funds back if you need them. Ideally, the 529 plan you start will help your loved ones pay for school — but if a medical problem or some other emergency arises, a 529 account can serve as a safety net.

The potential for decades of tax-free growth is one of the most attractive features of 529 plans. Consult a CPA before you open a 529 account or make a contribution to one.

Potential Pitfalls

If you don't use withdrawn funds from a 529 plan for qualifying education expenses, you might owe taxes. Any earnings in the account might result in income taxes due, and you might owe additional tax penalties.

Money in a 529 plan can also interfere with financial aid. When a student or their parents own the account, that money is reported as an asset on the student's Free Application for Federal Student Aid (FAFSA) form. Substantial 529 account balances could reduce available student aid. Withdrawals from 529 accounts, though, usually don't count as income on the FAFSA.

When a grandparent is the account owner, though, any money in a 529 plan generally isn't reported as an asset on the FAFSA. However, withdrawals could be treated as income, which could affect financial aid eligibility.

Who Owns a 529?

Usually, whoever opens and contributes to a 529 plan typically owns the account. That's often a parent or grandparent, although you name a beneficiary for each account — typically the child or grandchild you're saving the money for. However, 529 accounts also accept third-party contributions — meaning you could contribute to one you don't own.

When you open an account, as the account owner, you have the option of taking the money back. Though the goal for these accounts is to pay for education, that flexibility could be helpful if you experience hardship and you need the money for yourself. However, if you contribute to a 529 plan as a third party, you relinquish any access to the funds you contribute.

The Bottom Line

A 529 savings plan lets grandparents help with their extended family's education expenses — and maybe get a little tax break along the way, as withdrawals that go toward qualifying education expenses aren't subject to federal income tax. There might even be some state income tax incentives. 529 plans also provide a substantial amount of control for account owners, who can take money back if the student doesn't need all the money or if unexpected needs arise.