There are many ways that you can begin saving for your children or grandchildren’s college expenses: 529 plans are among the most popular types of accounts used to set aside these funds. There are a variety of factors you should consider in determining whether a 529 plan is the best option for your family, including some that may impact your estate planning.
A 529 plan, legally known as a “qualified tuition plan,” is a savings plan that provides tax advantages designed to encourage people to save for their children or grandchildren’s future education costs. They are known as 529 plans because they are authorized by Section 529 of the Internal Revenue Code, and they are available in every state and the District of Columbia.
What Are the Pros of 529 Plans?
Tax benefits: 529 plans allow investment earnings to grow tax-free. When you withdraw the money to use it for a qualified higher education expense or to pay tuition for elementary or secondary schools, the earnings are not subject to federal, and sometimes, state income tax. A 529 plan also allows you to make five years of tax-free gifts in one year per beneficiary (with some exceptions).
Changing beneficiaries: If the child initially named as a beneficiary does not attend college or does not need all of the funds in the 529 account, the account owner can change the beneficiary to another eligible family member without any gift or income tax consequences. In addition, no federal generation-skipping transfer tax will be incurred if the new beneficiary is a member of the same generation as the initial beneficiary.
What Are the Cons of 529 Plans?
Possibility of penalties: If withdrawals from 529 accounts are not used for qualified higher education expenses or tuition for elementary or secondary schools, the investment earnings will be subject to state and federal income tax, as well as a 10% federal tax penalty.
Eligibility for need-based financial aid: It is likely that the money invested in a 529 plan will have an impact on the beneficiary’s eligibility to receive need-based financial aid for college or elementary or secondary school tuition.
What are the Estate Planning Considerations?
A successor should be named: It is important for account owners to name both a primary and secondary successor in case the original owner passes away or becomes unable to make decisions regarding the account. It is crucial to name a successor who is trustworthy, as the successor will be able to make decisions about how the money is invested, when and how it is used for the beneficiary’s education expenses, and changing the beneficiary. If no successor is named, the new account owner may be decided through probate if there is a will or by operation of law if there is no will in place.
A revocable education trust might be a good alternative: A special purpose revocable education trust may provide more flexibility depending on your situation, as it allows the individual who sets it up to serve as the trustee and make distributions for the beneficiary’s education, but it can also be revoked or revised if the funds are needed for other purposes or if the beneficiary does not attend college. It will not provide the tax benefits of a 529 plan, but it may still be a better option for some families for whom flexibility is a priority.
If paying for your child or grandchild’s college education is one of your estate planning goals, and you are confused about the best way to save for those college expenses, I can help you think through which method will work best for you and your family. The strategies discussed above are only a few of the possibilities.