With the ongoing rise in the costs associated with a college education (i.e. tuition, room, board, books, etc.), the emphasis on saving for a child’s education from their early youth has grown. The “529 Plan” is a growing solution to this issue. Also known as a “Qualified Tuition Plan”, the 529 Plan is designed to fund the future education expenses of your child, grandchild, etc.
Named for section 529 of the Internal Revenue Code, these plans come in two flavors: Pre-paid tuition plans and college savings plans. Pre-paid tuitions plans are identical to their name, they permit one to purchase credits or future tuition at a participating school. Similarly, college savings plans function in the form of a savings account whereby one establishes an account for the purpose of payment of future college expenses of their child, grandchild, etc. With the college savings plan, the party making the contributions is given the flexibility to invest the funds leading up to the beneficiary reaching college age. For a brief comparison of the two savings plans, please refer to the chart below which is offered by www.sec.gov.
- Penalties – If you fund a 529 plan, failure to use that money for education expenses will result in a 10% federal income tax penalty. So the true benefit of the plan is only realized if the funds are used for college. Thus, there is risk in using the 529 plan as your chosen beneficiary may forego college, thus leaving you to incur the 10% penalty.
- Ownership – Pay close attention to the ownership of the 529 plan. In a best case scenario, neither a parent nor a child will own the 529 plan. This is because, should a child be the owner of his own 529 plan, he or she will incur a 20% income tax penalty whereas if a parent was the owner, they would incur a 5.6% penalty. The same holds true should a trust owned by either be the owner of a 529 plan. Thus, persons such as grandparents and extended relatives would make the best owners of these plans avoiding the penalties discussed above.
- Contingency – Another issue as to ownership is making sure that a contingent owner is named in case of death. Otherwise, should there be no contingent owner; the estate of the former owner assumes ownership thus giving the Personal Representative the option to change the beneficiary to anyone, including themselves.
- Deductions – There are no Federal Tax Deductions for 529 plans.
- Limits – Gift tax limits apply to 529 plans limiting contributions to $13,000 per beneficiary per taxable year.
The 529 plan is a good tax deferred savings tool for individuals who want to plan for their young relatives college educations. That said, when entering into a 529 plan, please make sure that you have your estate planning attorney incorporate it into your planning.
– Adam Abramowitz, JD and Gary Altman, Esq.