Ralph Bovitz, CPA, PFS

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Saving for College Just Got Easier and Tax Friendly

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.

      Hopefully, the 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.











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