By Ralph Bovitz, CPA, PFS
Under new Federal
tax rules, saving for college just got a bit easier and a bit more practical
for attorneys wishing to plan for their children’s higher education. More
practical because attorneys can save for college and pay for their children
to attend any college or approved vocational school in the country and
receive some tax breaks in the process.
Unlike the past,
you no longer have to decide in advance, like when the child is a year old,
which college he or she will attend at 18. Family members who establish a
college savings plan under the new Federal tax rules can accumulate funds
tax-deferred and ultimately spend them tax-free, in the right circumstances,
and the child can attend whatever school he or she selects or qualifies
for. This was made possible by improvements to a college education funding
provision in Internal Revenue Code Section 529. Plans established under
this provision are now commonly referred to as Section 529 plans. Most
states have or are in the process of conforming to Federal tax treatment.
Let’s look at some
of the tax benefits and incentives. Gifts over $11,000 to an individual, in
any one year, may trigger a gift tax. Assume your children’s grandparents
have a large estate and wish to help their grandchildren with college
education costs. A grandparent can setup a Section 529 plan for a child,
with a gift of up to $55,000 in the first year, and incur no gift tax
consequences. For a Section 529 plan, the contribution is considered a gift
made over a 5-year period. Should the grandparent die before 5 years has
elapsed, however, a pro rata portion of the gift is brought back into the
grandparent’s estate. To set aside more than $55,000 for an individual
grandchild, each grandparent may setup a plan, and benefit from the new gift
tax rules. In addition, such plans can be setup for any or all of the
family’s children or grandchildren. Plans must be established before the
child is 18 and the child must use all funds accumulated for qualified
education purposes, by age 30. Creating a Section 529 plan is not limited
to grandparents. Parents themselves, aunts and uncles can also contribute
to a Section 529 plan.
Section 529 plan assets will grow to meet the education costs when needed.
However, the Section 529 plan does not guarantee a specific fund balance
when it’s time for college. In fact, losses to original principal may occur
or only modest growth may result. For a guaranteed amount, grandparents
still have the opportunity to purchase shares in a prepaid tuition plan.
However, such plans generally limit expenditures to tuition and fees.
Although such plans may be used for out-of-state or private schools, the
prepaid plans may not meet the costs at those schools.
Section 529 plan
assets are invested by money managers who adhere to an investment program
that becomes more conservative, as the child gets closer to college age.
The grandparent who sets up the Section 529 plan cannot manage the account
or otherwise direct its investments. However, the grandparent can move the
account to another Section 529 plan, under certain circumstances, either
once a year or if the plan is assigned to a different child.
When the funds are
used for qualified education costs, there is no tax on the money withdrawn
from the plans. Qualified education costs eligible for Section 529 plan
funds have been broadened from meeting just tuition and fees to include room
and board, books, supplies and equipment.
Two other tax
features that should appeal to grandparents and other family members setting
up these plans are that, while the plan assets are removed from their
estate, the plan assets can be reclaimed by them at any time. This becomes
important if the grandparents, for example, encounter financial difficulties
in the future and need funds to maintain their life style. The only penalty
is the tax on growth, when the plan funds are used to pay for non-qualified
education expenses, plus a 10% penalty. Moreover, the grandparents who setup
the Section 529 plan are not required to give any reason for reclaiming the
Section 529 plan assets. Thus, the child can be denied access to the Plan
assets if he or she experiences a “Porsche” syndrome episode, preferring a
new car to a college education. The plan's assets are still under the
control of the grandparent and do not even have to be made known to the
child but are still eligible for the gift and income tax benefits. Gift tax
rules generally require loss of control by the donor, to realize a gift tax
benefit, but not in the case of 529 plans.
There are nearly
40 states, including California, offering Section 529 plans and
approximately 18 money management firms directing the investment of plan
assets in those states. The money managers include well-known mutual funds
and brokerage houses. Thus, an attorney or attorney’s family member can
participate in a plan located in Iowa and use the funds accumulated to pay
for college in California. Or, accumulate funds in a plan located in
California and use the funds to pay for college in Ohio.
While, it is now
easier to save for college, care needs to be taken in selecting the plan
that will meet your needs now and in the future. There are no uniform rules
governing the Section 529 plans, beyond the rules to realize tax benefits.
Thus, you want to know about any restrictions in selecting beneficiaries,
minimum and maximum contributions to the plan allowed, how easily it is to
roll a plan into another plan or to another beneficiary, state tax treatment
and what are the refund policies. Where one plan appears negative in one
category, look into another plan, remembering the funds can be used to fund
a college education in another state, regardless of which state’s Section
529 plan is selected.