Posted: September 24, 2012
Cash for the college-bound
The best reasons to have a 529 planWayne Farlow
A 529 college savings plan is often the best way to save for a child’s higher education expenses. Let’s explore some of the ways that 529 college savings plans provide tax savings, flexibility, safety and even estate-planning opportunities for parents and grandparents of college-bound children.
1) Tax Savings - The gift tax exclusion allows an individual to contribute up to $13,000 or a couple to contribute $26,000 annually for each 529 plan beneficiary. A special provision of 529 plans allows the gift to be of up to five times the annual contribution limit in one year. Thus, a parent (or grandparent) may individually contribute $65,000 to each child’s plan, while a couple may contribute $130,000 to each beneficiary.
If the gift is made when the beneficiary is young, it will grow tax-free for many years. As long as the funds are used for qualified higher education expenses, the funds can be withdrawn without ever paying taxes on the 529 plan’s income and growth.
In many states, including Colorado, contributions to a 529 plan are state tax deductible in the year in which the contribution is made. If you have a child currently in college or about to enter college, the funds required for the current year’s college expenditures can be put into the ultrasafe money market account at CollegeInvest (the Colorado 529 plan provider). These funds may be immediately withdrawn to pay the beneficiary’s college expenses and you receive a Colorado income tax deduction for the full amount that was contributed to the 529 plan.
2) Flexibility – 529 college savings plans offer incredible flexibility when a beneficiary decides not to enter college. Here is an example: A couple sets up a 529 plan for each of their three children shortly after each is born. When each child turns 18, their 529 plans have grown to $50,000. If one child decides to not attend college, the parents may change the beneficiary of that child’s plan to one of their other children. When this child finishes college, if assets still remain in their 529 plan, the beneficiary can once again be changed to any child still attending college or graduate school.
If all three children have completed college and there are still remaining funds in the 529 plans, the beneficiary can be changed to a parent. If the parent does not use all of the remaining funds, the beneficiary could be changed to a niece, nephew or grandchild. The flexibility that 529 plans offer in choosing and changing beneficiaries helps you assure that the funds will be eventually used.
3) Safety – When a gift is made to a child or grandchild, it is considered a “completed gift” with no ability to reclaim it. A 529 college savings plan offers the funder the ability to reclaim their gift at any time if required.
The 529 plan funder/owner may reclaim any or all of the funds in a 529 plan. If funds are withdrawn, all interest and income would be taxable and a 10% penalty on the income would be assessed. Thus, if the $50,000 that funded a 529 college savings plan has grown to $60,000, the funder may withdraw the full amount, paying ordinary income taxes on $10,000 plus a 10% ($1,000) penalty. This “safety valve” is unique for gifts to a 529 college savings plan.
4) Estate Planning – In 2013, the $5 Million gift tax exemption will likely expire. A 529 college savings plan offers a unique estate planning opportunity. Wealthy grandparents can contribute up to $130,000 to a 529 plan for each grandchild. If the grandparents have ten grandchildren (or grand nieces and nephews) they can remove $1.3 Million from their estate in a single year. If the grandparents ever need to reclaim some or all of these funds, they can reclaim them at any time (see 3 above).
The flexibility to change the beneficiary, change plans from one state to another or use funds in one state for higher education expenses anywhere in the world, make 529 college savings plans one of the most flexible savings tools available.
Wayne Farlow is the founder of Financial Abundance, LLC, a Registered Investment Advisor firm. He is a Certified Financial Planner (CFP®), focusing on Retirement Planning, Investment Management, Small Business Owner Planning and Sudden Wealth/Inheritance Planning. His book, “Financial Abundance Guide,” is available free at www.farlowfinancial.com . He can be reached at firstname.lastname@example.org or at 303-554-0309.