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Always Have a Plan for Leftover 529 Plan
Money
With the high cost of education, it's hard to envision that
there might be money left over, but it does happen. Kids get
scholarships; they might finish early; sometimes they quit
school never to return.
In the case of 529 college savings plans, it's particularly
important to have a backup plan for the possibility of leftover
funds, not only to support another family member's educational
goals, but as a potential addition to your estate planning.
As a refresher, the 529 college savings plans — named for the
federal law that created them in 1996 — allow a parent to open a
tax-deferred college savings plan with as little as $25 to start
in some states. You should know that a 529 college savings plan
is NOT the same thing as a 529 prepaid college tuition plan.
Prepaid tuition plans are just that — tax-deferred savings plans
that allow you to save for tuition for in-state schools (though
some plans allow you to transfer out a portion of those assets
to out-of-state schools). Also, it's important to note that
prepaid tuition plans are not an automatic guarantee a student
will get into that college.
As part of sweeping pension reform signed into law by
President Bush in 2006, withdrawals from 529 plans are now
permanently tax-free. In some states, contributions may also be
deductible on state tax returns. All 50 states now have 529 college savings plans, and a majority of them
provide
additional incentives, such as a state-tax deduction to in-state
residents who invest in their respective plan.
It's a good idea to have your financial adviser help you sort
through the details of various state plans. There are various
services — including Morningstar Inc. — that now rank the
offerings of each state's plan. SavingforCollege.com
and finaid.org
are leading sites to help educate you in how these plans work.
So, if you've made all these moves, how should you handle
surplus 529 funds? There are a few options:
Change the beneficiary. If Student #1 doesn't spend
out the funds, you can replace the beneficiary with another
blood relation — that means brother, sister, first cousin, even
you or your spouse — to continue spending down those funds for
educational expenses. Also, if you have a grandchild headed for
college, you can arrange for your 529 plan to make the
withdrawal payable to your grandchild as the beneficiary.
Take a penalty and spend the money on whatever you want.
This isn't the most sensible financial option, but you do have
the option to take leftover funds as a nonqualified distribution
for your own non-educational use. However, you'll owe ordinary
federal tax with an additional 10 percent on the earnings
portion of the distribution. Don't forget state tax, either.
Let your successor owner make the decisions. When you
apply for the account, you are asked to name a successor owner.
When you die, you can simply trust the successor owner or the
beneficiary of the funds to do what they want with the money.
September 2008 — This column is produced by the Financial
Planning Association, the membership organization for the
financial planning community, and is provided by Don McCarty of
Financial Decision Partners, a local member of the FPA.
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