If you are a new grandparent, you may be thinking of ways to help your grandchildren prepare for college. A 529 college savings plan can be a good way to help as you enhance your legacy when you map out your estate plan.
529 College Savings Plan
A 529 college savings plan is a popular tool for setting aside funds for a grandchild’s education. This type of account has gained even more flexibility in recent years, making it an even better option for families.
Similar to a Roth individual retirement account (IRA), contributions to a 529 plan are made with after-tax dollars. Once in the account, the money grows tax-free over time.
The real benefit comes when it’s time for the account beneficiary to withdraw funds for educational purposes. These withdrawals are also tax-free, as long as they are used for qualified education expenses.
These qualified expenses include more than just tuition. Funds can be used for books, supplies, fees, and even room and board. This makes the 529 plan a well-rounded option to cover the broad range of costs associated with higher education.
Recent changes have also expanded the possibilities for 529 plans. Under the Tax Cuts and Jobs Act of 2017, funds can now be used for K-12 expenses, including private school tuition, with a withdrawal limit of $10,000 per child, per year.
Savings Plans vs. Prepaid Tuition Plans
When considering a 529 plan, you have two main options: a savings plan or a prepaid tuition plan.
A 529 savings plan allows you to invest your contributions in mutual funds, which grow over time. The money can then be used for any qualifying education expense, offering flexibility for the account beneficiary.
Alternatively, you could choose a 529 prepaid tuition plan. With this option, you purchase credits for in-state college tuition at today’s rates.
The advantage here is that you lock in current tuition prices, potentially saving money in the future as tuition costs rise. However, the plan is more limited, as it primarily covers tuition and may not include other expenses like housing or books.
The availability of the prepaid accounts has been waning over the years. They are now available in just nine states, California isn’t one of them.
More Savings Plan Details
In addition to tax-free growth and withdrawals, 529 savings plans offer several other benefits, making them an attractive choice for grandparents and parents alike.
For example, in some states, contributions to a 529 plan are eligible for a state income tax deduction. Unfortunately, California is not in this group.
Another benefit is that 529 plans allow for flexibility if the beneficiary doesn’t need all the funds. If your grandchild receives a scholarship or doesn’t use all the money, you can change the plan’s beneficiary to another family member without any tax penalties.
Each 529 plan has a contribution limit, which varies depending on the specific plan. In many cases, these limits are quite high, often reaching $500,000. This allows you to invest significant amounts for future education costs over time.
It’s also important to note that while 529 plans are intended for educational purposes, you do have the option to withdraw funds for any reason at any time. However, any earnings on the withdrawals would be subject to taxes, and a 10% penalty would apply.
Estate Tax Considerations
For families concerned about the federal estate tax, 529 college savings plans can be part of an estate tax planning strategy. The federal estate tax is unified with the gift tax, and each year, you are allowed to gift up to $18,000 per person without triggering gift tax obligations.
As a grandparent, you could contribute as much as $18,000 per year to a 529 plan for each grandchild. If you’re married, you and your spouse could gift up to $36,000 annually per grandchild, taking advantage of the gift tax exclusion. This approach allows you to reduce the taxable value of your estate while also funding your grandchild’s education.
We Are Here to Help!
A comprehensive estate plan should consider how best to provide for your loved ones. If you’re ready to take the next step in planning for your family’s future, we can help you create a plan that incorporates tools like 529 college savings plans.
You can call us at 707-769-9975 to schedule a consultation at our Petaluma, CA estate planning office, and you can alternately use our contact form to send us a message.
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