With the high costs of college these days, another frequent inquiry we get from clients with grandchildren is how to set aside funds for a grandchild’s education. A commonly overlooked planning option is the Education Savings Account authorized by Internal Revenue Code Section 529. Often referred to as a “529 account”, this planning option permits you to reduce your taxable estate while earmarking funds for the higher education of a grandchild or any other family member, for that matter. Funds contributed to such accounts are invested to pay for a grandchild’s college tuition, room and board, or other expenses. Under the new tax law passed late last year, $10,000 of the funds in these accounts can now be used each year to pay for private school tuition at the K-12 level, not just college.
In 2018, you can contribute up to $15,000 per year (or $30,000 for a married couple) to 529 accounts without incurring a gift tax consequence. You can also “front load” the account by contributing up to $75,000 ($150,000 for a married couple) in the first year of a five-year period, as long as there are no additional gifts to that same beneficiary over the next five years. Also, if you die within the five-year period, the portion of the contribution for the years following your death are included in your estate.
Interestingly, donors to these accounts can take the money back later if needed, although they pay a penalty of 10 percent of earnings. However, this power to control the assets means that the funds in a 529 account typically are counted as an available asset under Medi-Cal’s rules in the event the account holder requires long-term care.
While these accounts are intended to be used for education expenses, if the student uses 529 account funds for any purpose other than higher education, the earnings are taxed as ordinary income to the account owner and a 10 percent penalty is assessed on investment gains.
When a grandparent establishes a 529 account, such accounts generally do not affect a grandchild’s eligibility for financial aid.
Under the 529 rules, you can change beneficiaries at any time, as long as the new beneficiary is a member of the original beneficiary’s family.
For many, the 529 account is a better option for funding education than simply leaving a gift to the grandchild in your will or trust. This is particularly so when the student will likely need the money before your death.
A good source for information on 529 plans is www.savingforcollege.com.