12 May 529 plan funding for a grandchild

Q. I’m great grandmother for a four-month-old. I would like to help his parents for the future by opening a 529 college savings account. I live in the Washington state and they are in New Jersey. Can you give me some direction? I have a hard time saving.
— Great Grandma

A. This is a great gift to your grandchild.

Opening a 529 plan gives you the ability to put money away for your grandchild’s higher education in an account that has tax-free earnings as long as the funds are ultimately used for education, said Laurie Wolfe, a certified public accountant with Lassus Wherley in New Providence.

A key benefit to contributing money to a 529 plan is that you retain ownership and control over the account, even though the money deposited is a completed gift, Wolfe said.

“Your grandchild will not have any control over the account or when distributions are made, so that shiny motorcycle for sale on the corner will stay put,” she said.

Another key benefit is the ability to change the beneficiary of the account to a different member of the beneficiary’s family, Wolfe said.

“This is important in the event the account is overfunded or not used by your grandson,” she said. “The definition of family member is very broad, including cousins and spouses of family members.”

Also, if for some reason you found that you were in need of the funds yourself, you could take a distribution.

In that case, you would pay tax and a 10 percent penalty on the earnings portion of the withdrawal because it would not be used for qualified education expenses, Wolfe said. This provides a little safety net should you need access to those funds.

You can also use 529 plan contributions as part of your estate plan because it will remove funds from your estate.

Wolfe said the contribution is considered a gift subject to the federal gift tax.

There is an annual gift tax exclusion — currently $14,000 per beneficiary per year — that is not subject to the gift tax, she said.

“You may also contribute a lump sum of up to five times the annual exclusion amount to each beneficiary,” she said. “You would then have to wait 5 years before gifts to that same beneficiary would be eligible for the exclusion.”

Even if your gifts go over the exclusion amount, Wolfe said, there is a lifetime exemption amount, which is currently $5.49 million dollars.

Washington State, your home state, does not have a gift tax on lifetime transfers, but it does have an estate tax on estates valued in excess of $2.129 million, Wolfe said, so this is something to consider during estate planning.

There are also a few things you should look out for.

Wolfe said you may already have estate planning in effect using the annual gift tax exclusion, with a life insurance trust or family limited partnership as part of your plan.

“If you are anticipating that someday you may need Medicaid assistance, your state will likely consider 529 accounts owned by you to be your assets and you would have to deplete them before qualifying,” Wolfe said.

Also, some colleges will consider 529 assets, even if owned by grandparents, when deciding whether to offer a grant or other award to your grandchild, she said.

And if someone else also owns a 529 account with your grandson as the named beneficiary, then you will have to coordinate with them when making distributions to avoid too much being distributed.

You said you have a hard time saving money.

“Many of these plans offer a monthly contribution option and you can set up recurring contributions which will transfer directly from your checking account,” Wolfe said. “Of course, these can be discontinued or changed any time you wish.”

As for what plan you should choose, most states offer a 529 plan that is open to residents of any state, Wolfe said.

Some states offer tax deductions for contributions made by residents of their own state and some offer these deductions whether or not you are a resident of the state, she said.

“Washington State, your home state, does not have an income tax and so there is no need for you to consider this when choosing a plan,” she said.

So your plan selection should consider the fees charged, contribution limits and the quantity and quality of the investment options offered.

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This story was first published in May 2017.