Parenting is a Journey
An Adventure of Discovery Not Only of our Children But of Ourselves as Well
Load 529 plan with gift tax exemption
By Aaron Crowe
Grandparents and other relatives wanting to be remembered for their generosity have a better option than pushing a few bucks in a kid’s hand a few times a year — putting up to $14,000 tax free into a 529 college savings plan annually.
Because 529 plan contributions are considered gifts by the IRS, the gift tax exclusion is a way for grandparents to avoid estate taxes, lower the value of their estates and contribute to a grandchild’s education.
The federal income tax advantages will only grow for the child and their parents. Money in a 529 plan grows tax free and is withdrawn without paying taxes when used for college or grad school expenses.
A 529 account can grow much more than a taxable savings account. A 529 can also be front-loaded, with up to five years of gifts that can be contributed when opening an account.
Each person can give up to $14,000 each year to any number of people without facing a gift tax. A married couple could give away $28,000 and could front-load it five times for a total initial contribution of $140,000 per child. That’s a heck of a start to saving for college.
Grandparents and other relatives can also get in on front-loading a 529 plan. Instead of giving $14,000 per year, they can give five years’ worth of contributions at once — $70,000. They can’t contribute more for another four years, however.
Advantages of 529s
Called 529 plans because that’s the section of the IRS code they’re authorized by, 529s are legally knows as “qualified tuition plans.” The savings plans are sponsored by a state or state agency, and the money must be used for higher education expenses.
These include room and board, tuition, books, computers and other college costs. If a 529 account is in a parent’s name with the child as beneficiary, the parent has control over withdrawing the money. The money can be used at any college your child chooses.
If the child doesn’t go to college, the beneficiary can be changed to another family member, such as a sibling or cousin, or even to the parent if they want to go to college.
If the money isn’t used for eligible expenses, it will be taxed as your ordinary income tax rate, along with a 10 percent penalty on the earnings.
T. Rowe Price offers the example of contributing $5,000 to a 529 and having it earn $2,000, for a balance of $7,000. If you withdraw all $7,000, only the $2,000 in earnings is taxed and the 10 percent penalty is paid on the earnings. Assuming you’re in a 25 percent tax bracket, you’d pay 25 percent, along with 10 percent of the $2,000 in taxes and penalties of $700, leaving you with $6,300 to spend.
Plans vary by state, but most 529 plans work like mutual funds. Your money is invested in stocks and bonds with the hope that it will grow faster than a savings account.
You should research any 529 plan before joining, making sure you’re comfortable with the investments and can set your risk level, such as from conservative to aggressive. Look up the plan’s recent performance.
To make the most of a 529, contribute to it regularly through automatic investments that are withdrawn each month from your checking or savings account.
A plan for the grandparent who wants control
Since a 529 plan is usually set up by a parent, the parent controls when the money is withdrawn for college expenses. Grandparents who want more control over their college donations, however, can set up a separate 529 account for a grandchild.
There are no limitations to how many 529 accounts someone can have, though there is a limit of how much can be contributed per child of about $250,000 in most states.
Setting up multiple 529 accounts could lead to some tax confusion. Some states give tax benefits only to the account owner, while others give them to the account owner and the contributor.
Putting $14,000 into a 529 plan each year for a grandchild is an extremely generous way to get in the good graces of a grandchild and their parents. It’s said that money can’t buy love, but the gift of a college education should be worth a lot of extra hugs and kisses.
Aaron Crowe is a freelance journalist in the Bay Area who has worked as a newspaper editor and reporter. He now writes for websites, specializing in personal finance writing.