Legal Blog

November 6, 2019

What You Need to Know About 529 Plans

Let’s face it, college is expensive.  Reports for the 2019-2020 school year show the average cost of tuition and fees is $10,116 at an in-state public university and $36,801 at a private university.  When you then consider the additional costs of housing, books, and meal plans the total for your child to attend college may seem out of reach.  The good news is that there are many ways that you can begin saving for your children or grandchildren’s college expenses.  Of the many ways in which you can start to plan, a 529 plan is likely the most popular type of accounts used to set aside school funds. When considering if  a 529 plan is the best option for your family, you should consider certain factors including some that may impact your estate planning.  Let’s get straight to it!

What Is a 529 Plan?

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. There are two types of 529 plans:

Prepaid tuition plans.  Prepaid tuition plans let individuals purchase units or credits for a beneficiary’s future tuition and mandatory fees, in advance and at the current prices, helping to avoid paying the higher costs that will be charged by the college the beneficiary will attend in the future. These plans are usually available only for public and in-state colleges, cannot be used for room and board, and cannot be used to prepay tuition for elementary and secondary schools.  If a child later decides to attend a private college or university, prepaid funds can be applied to tuition at most private post secondary institutions.

Education savings plan.  These plans enable individuals to open investment accounts to save for any qualified higher education expenses. Unlike prepaid tuition plans, they can be used not only for tuition and mandatory fees, but also for college expenses such as room and board, books, computers, and software. They also typically can be used for any college or university, unlike prepaid tuition plans, which are usually limited to in-state and public colleges. Education savings plans can be used to pay for elementary or secondary school education as well.

What Are the Pros and Cons to 529 Plans?

Pros

Tax benefits.  529 plans provide several tax benefits:

  • 529 plans allow investment earnings to grow tax-free: generally, the longer the funds are invested, the greater the tax benefit you will receive. 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 allows you to make five years of tax-free gifts in one year per beneficiary. However, no additional gifts can be made to the same beneficiary for five years, and if the donor dies before the five years have passed, a prorated portion of the gift is returned to the donor’s taxable estate.

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.

Cons

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.

Fees. Education savings plans and prepaid tuition plans typically charge enrollment and application fees, as well as ongoing administrative, account maintenance, and/or asset management fees. If an education savings plan is purchased from a broker, there may be additional fees.

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.

Estate Planning Considerations

Name a successor. It is important for account owners to name both a primary and secondary successor, i.e., someone else who can control the account 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. The successor will also have the discretion to make nonqualified withdrawals for a purpose otherthan the intended educational purposes. 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. Some plans have their own rules of succession and may name the beneficiary as the account owner if the beneficiary is over the age of 18. This may not be an optimal result if the beneficiary is not mature enough to make wise decisions about the funds. If the beneficiary is not yet a legal adult, the beneficiary’s guardian may be named the account owner.

We Can Help

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, we can help you think through which method will work best for you and your family. Give us a call at (954) 999-9683 – we are here to help!

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