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College Savings Before Your Student is Born: Qualified Tuition Plans to Educate Family Members from Kindergarten to Grad School

By James Lanham

January 14, 2019

                 Most new parents are aware that college for their newborns could easily cost over $100,000 per year by the time Junior matriculates.  A degree at Claremont McKenna College, Sarah Lawrence College, the University of Chicago or Columbia already tips the scale at over $65,000 per year[1] before scholarships and aid kick in.  Private schools from Kindergarten through twelfth grade can easily top $10,000 per year.  The North American Montessori Teachers' Association notes that tuition can range from $999 per year to over $14,000 per year.[2]  Private high school tuition in Ohio averages over $9,000 per year while a private high school tuition in the Connecticut averages over $32,000 per year.[3]  A law degree at Vanderbilt University is a mere $375,000.[4]  Was it Willie Nelson that sang the song Mamas, Don’t Let Your Babies Grow up to be Lawyers?”  One solution to ever escalating educational costs is start college savings EVEN BEFORE Junior is born by investing in a tax-free[5] Section 529 Qualified Tuition Plan. 

                These Section 529 college savings plans may now be used to pay up to $10,000 tuition for private schools (including religious schools) from Kindergarten through twelfth grade,[6] along with being eligible to pay virtually any college related expenses.[7]   Section 529 plans are available directly from the state plans such as Ohio’s “College Advantage Plan”[8] or through numerous financial planning services.  These plans are state specific to some extent, offering different investment options state by state and are even tax deductible on many state income tax returns.[9]  Ohio allows up to a $4,000 state income tax deduction per beneficiary contribution each year if the 529 plan is purchased from the Ohio College Advantage Plan.  By contrast, a Pennsylvania resident can deduct up to $13,000 per beneficiary per contributor each year irrespective of where the 529 plan was purchased.  One is not limited to purchasing a 529 plan from one’s state of residence.

                All 529 plans, wherever purchased, do not tax the growth and income of the plan investments if the proceeds are used for Kindergarten through twelfth grade tuition or for college or graduate school “qualified higher education expenses.”  The qualified expenses for post-secondary education include tuition, fees, books, supplies, and equipment required for the enrollment or attendance of a designated beneficiary at an eligible educational institution, and expenses for special needs services in the case of a special needs beneficiary which are incurred in connection with such enrollment or attendance.  Also qualified for college or graduate school are computer related expenses (purchase of computer or peripheral equipment, computer software, or Internet access and related services) if such expenses are to be used primarily by the beneficiary during any of the years the beneficiary is enrolled at an eligible educational institution.  Students who attend college at least half time may also use 529 plan funds for room and board.

                To fund a 529 plan before Junior is born, you must designate a living beneficiary of the 529 plan who is a qualified “family member.”   Once your child is born, you may transfer the beneficiary designation to your child from the qualified family member.  A family member includes a first cousin, a child, a brother, sister, stepbrother, stepsister, father or mother or ancestor of either, stepfather, stepmother, niece or nephew, aunt or uncle and spouses of most of these members.  If the new beneficiary (your new baby) is in the same generation as the old beneficiary (e.g. a first cousin or sibling), there are no gift tax ramifications.  If the parent is the designated beneficiary and changes the beneficiary to a child (or to any person in a lower generation such as a niece or nephew), a “taxable gift” occurs, but at the current time, no gift tax must be paid unless the lifetime gifts of that parent exceed $11.18 million.  Additionally, if the amount involved in the beneficiary change is less than $15,000,[10] there is never a gift tax issue.  This is a long way of saying you can set up a 529 plan account for an unborn child by naming that prospective child’s cousin or sibling (or if none, then yourself assuming you’re not worth over $11 million) as the beneficiary, then changing the beneficiary to your new baby once born into the world.

                Friends and family members can contribute to the 529 plan accounts for your kiddos, giving up to the $15,000 per donor per beneficiary each year without reporting the gift, or up to $75,000 in a lump sum to cover a five year period of annual exclusion gifts.  This latter option allows a wealthy grandfather and grandmother to each add $75,000 to the child’s 529 plan in a single contribution so the entire amount can start accumulating growth (if the market rises) and income for the account.  A gift tax report is required for this option, but, again, such a gift is not subject to paying any gift tax.  Any further contributions by those grandparents over the five year period would be subject to gift tax reporting.

                If you do not use the 529 plan funds for private Kindergarten through twelfth grade school funding or college or graduate school, tax will be due on the growth and income when the funds are distributed to the beneficiary along with a ten percent additional penalty.  The other option would be to change the beneficiary to a different qualified “family member” who might use the funds for education.  In any event, the 529 plan is a solid planning tool for educating your child and can be started even before conceiving the child if children are in your future.


 

[1] https://www.theedadvocate.org/2018-5-expensive-colleges-america/

[2] http://www.montessori-namta.org/FAQ/Montessori-Education/How-much-does-Montessori-cost

[3] https://www.privateschoolreview.com/tuition-stats/private-school-cost-by-state

[4] https://www.mostluxuriouslist.com/top-10-most-expensive-degrees-in-the-world/

[5] Free from estate, gift and income taxes if properly funded and disbursed for educational purposes

[6] 29 U.S. Code § 529(c)(7); covers tuition only for enrollment or attendance at an elementary or secondary public, private, or religious school

[7] 26 U.S. Code § 529 - Qualified Tuition Programs

[8] Enrollment for Ohio’s College Advantage Plan is available at https://www.mycollegeadvantagedirect.com/ohtpl/uii529enroll/gettingStarted.do

[9] Arizona, Kansas, Maine, Minnesota, Missouri, Montana and Pennsylvania provide a state income tax deduction irrespective of the state in which the 529 plan is purchased.

[10] The current annual exclusion for gifts per donor per donee; subject to annual changes

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