A 529 plan is an education savings plan operated by a state or educational institution designed to help families set aside funds for future college costs.
Q. Is a 529 plan the best option for college savings, and when is the best time to start investing in one?
One of the major non-tax-related advantages of the 529 plan pertains to control. As opposed to Uniform Gift to Minors Act (UGMA) accounts or Uniform Transfer to Minors Act (UTMA) accounts, where the minor takes ownership of the account once they reach the age of majority, 529 plans allow the account owner, usually a parent or grandparent, to maintain full control of the assets as well as the timing of the distributions.
The owner also has the right to change the beneficiary of the account at any time. Doing so creates no tax liability as long as the new beneficiary is a member of the previous beneficiary's family, which by definition includes parents, siblings, aunts, uncles, cousins, nieces, and nephews.
If you choose not to name a new beneficiary and would prefer to simply withdraw the funds for uses unrelated to higher education costs, the earnings portion of the withdrawals will be subject to a 10% federal tax penalty, as well as state and federal income taxes. In addition, if the plan you used provided you with state tax deductions, depending on the state, the past contributions may be subject to a "recapture," meaning you may be retroactively taxed on amounts for which you took a deduction.
If you are concerned about the 529 restricting your ability to obtain financial aid, calculating the impact is relatively simple when a parent is the owner of the 529 plan, since it is reported on the federal financial aid application as a parental asset. This is something to consider when you take out a 529 plan. Schools individually set their own rules when determining need-based scholarships, and many schools are starting to adjust awards when they discover 529 plans in the family.
When deciding if a 529 plan is right for you, there are numerous, complicated decisions you must make. Some families choose to distribute college savings through other investment vehicles to reduce the risk of relying too heavily on any one investment. If you need guidance in determining whether a 529 plan is appropriate for you, please be sure to contact your tax and financial advisers for assistance.
Q. Should I take advantage of the new higher gift tax exemptions?
A. At the risk of being vague, the answer depends on many complicated issues that require careful consideration and a detailed discussion with your estate-planning attorney. The lifetime gift tax exemption is now $5 million (formerly $1 million) for 2011 and 2012. This means that individuals can gift an extra $4 million of assets without the gift tax assessment. That number is doubled to $8 million for married couples.
When taking advantage of this increased exemption, income and appreciation are removed from the estate of the donor. Assets with the greatest appreciation over your lifetime are generally the best selection when deciding what to gift. Furthermore, you and your spouse can each give $13,000 per year without reducing your lifetime gift tax exemptions. These annual exclusion gifts, which include future appreciation, are permanently out of your estate.
Joel M. Blau, CFP, is president and Ronald J. Paprocki, JD, CFP, CHBC, is chief executive officer of MEDIQUS Asset Advisors, Inc. in Chicago. They can be reached at 800-883-8555 or firstname.lastname@example.org