Saving for college is a priority among many parents. Often we are asked about the right savings vehicle for college education. There are a few that parents can choose from between Coverdell ESAs, prepaid tuition and 529 college savings savings plans.
We’ll discuss the 529 plan here. The 529 plan is essentially a college savings vehicle very similar to an IRA or an employer-sponsored plan. Depending on the state you live in your state may have a 529 plan that will have access to stock and bond mutual funds and or a pre-determined mix that will invest the money and allocate it for you depending on your risk tolerance or your time horizon upon entering college.
Many states such as Illinois well even offer a state tax deduction for any contributions that you make up to a certain dollar limit. The beauty of 529 savings plans is that there is no income phase out so parents who make quite a bit of money can still contribute.
For grandparents wanting to put their grandkids through school or help pay for college a 529 can be an excellent way to help do that as well as reduced their estate. For 2014, a person can gift up to $14,000 to a 529 savings plan and couples who elect to split gifts can contribute $28,000 for one individual (529 beneficiary). This can be done for multiple beneficiaries that each have a 529 plan.
For couples who want to make an even bigger contribution they are allowed to make a five-year pro-rata contribution to a 529 savings plan. For a single person this means contributing up to $70,000 at one time without incurring any gift tax consequences and for a married couple contributing up to $140,000 at one time based on this special five year pro-rata rule. Once this is done another gift cannot be made until the five year period is over. The process can be repeated again for another 5 year pro-rata period.
From an estate planning perspective once the 5 years is up, the gifted money is removed from the estate.
Money contributed to 529 plans grow tax deferred and qualified withdrawals from the 529 for education expenses are then tax free. Withdrawals not used for expenses are subject to ordinary income tax and a 10% penalty.
Another way for a grandparent to remove money from the estate is to make a direct payment for tuition to the college or university the grandchild attends. This direct tuition payment does not count toward the annual exclusion and can be done for any number of grandchildren. Keep in mind that the payment must go for the tuition and directly to the school. If the grandparent pays the grandchild directly, they can use the annual exclusion, but if the tuition is $25,000 and the exclusion is only $14,000 (single) then there may be gift tax consequences.