Save for future college costs with a 529 plan

Joel M Blau, CFP

Ronald J. Paprocki, JD, CFP, CHBC

What is the most popular savings plan for future college costs?

Among the various choices for saving for college, attention seems to be focused on the section 529 plan. Founded in 1996 but not made federally tax-free until 2002, the 529 plan has sparked a dramatic increase in college savings both by parents and grandparents. Investors are drawn to the high limits of contribution as well as the tax-free growth and more liberal withdrawal provisions. The benefit to grandparents with substantial estates is that they can transfer money out of their estate to open the account for their grandchildren while still maintaining control of the assets while they are alive.

Section 529 savings plans do not offer a guarantee that the funds accumulated will be sufficient to pay future education costs. Whatever the fund grows to is what will be available. The various state plans offer many investment options based on the amount of risk an investor wants to take. Many states also offer plans designed around the child’s age, typically becoming more conservative as the child approaches college age.

While many savings incentive plans typically limit participation based on annual earnings, the 529 plan is available to all taxpayers regardless of their income. The investor receives the advantages of tax-free buildup and withdrawal, limited control over the funds invested, and no restrictions as to the school attended, as long as the money is used for higher education.

Almost all states offer their own section 529 plan, which is managed by an investment management company chosen by each state. While the Internal Revenue Service permits tax-free buildup as well as withdrawals, a state can add its own perks, such as state tax deductions on deposits. However, if funds are not withdrawn to pay higher education expenses, the taxpayer must pay tax on the gains in addition to a 10% IRS penalty. This situation can be avoided by using the remaining funds for other family members (such as siblings) under the same criteria.

While just the basic features of section 529 plans are very attractive, physicians may realize substantial benefits that have nothing to do with saving for college education costs. With traditional custodial accounts, such as Uniform Gift/Transfer to Minors Act accounts (UGMA/UTMA), gifts can be made tax-free through use of annual exclusion gifts, currently $14,000. From an estate tax standpoint, these irrevocable gifts are usually considered as removed from the donor’s estate, as long as the donor is not the custodian of the account.

The section 529 plan takes it a step further by allowing a taxpayer to make 5 years of excluded gifts in 1 year, without taxation, for a maximum gift of $70,000 from each donor. While on the surface it appears to be a great way to remove assets from a grandparent’s or parent’s estate, be aware that if the donor dies during that 5-year period, gifts attributed to future years will return to the donor’s estate for purposes of calculating their estate tax.

Also worth considering is the use of section 529 plans as an asset protection strategy. As these accounts grow in value, asset protection will become a higher priority, especially in light of judgments that go beyond malpractice insurance coverage limits. What we do know is that the ability of judgment creditors to reach section 529 assets varies from state to state. This is especially important since donors are not mandated to use the plan offered through their own state. The restrictions do vary, with some states offering limited levels of protection. States with statutes restricting access by the donor’s creditors obviously offer a greater level of asset protection.

When you are evaluating and comparing section 529 plans, many issues must be weighed carefully prior to implementation. Be sure to consult with your financial adviser for assistance in selecting the most advantageous plan for your own specific situation.

In the event of a divorce, how can a retirement plan be divided?

Retirement assets, categorized into qualified retirement plans (defined benefit plans and defined contribution plans) or individual retirement accounts (IRAs), can be divided like any other part of the marital estate. But in order to divide a qualified retirement plan, you will need to obtain a qualified domestic relations order (QDRO). A QDRO is a judgment, decree, or court order issued to give a spouse, former spouse, child, or dependent of a participant in a retirement plan the right to receive all or part of the benefits. Without a QDRO, the plan administrator would not be able to release the assets to someone other than the account holder.UT