Send Your Grandchild to College

Grandparents wanting to set aside funds for their grandchildren's future college education costs should be giving real attention to Section 529 or 529 plans. Named after a section of the Internal Revenue Code, 529 plans were greatly enhanced by last year's tax reform act.

When you open a 529 account for a beneficiary such as your grandchild, you contribute after-tax dollars. Money in the account then grows tax-deferred; and when it is taken out, no federal or state taxes are owed if the funds are used for qualified college education expenses (tuition, books, room and board).

• These plans are sponsored by individual states - every state has or is developing a 529 plan. You do not have to invest in your state's plan. If you are a California resident, for example, you might choose to invest in Wisconsin's plan if you think it is superior. Some states (but not California) sell their plans through brokers and financial advisors.
• Regardless of which state's plan you choose, the funds in your 529 account can be used at any accredited public or private college in the United States.
• When you open a 529 plan account, you are the account owner and your grandchild is the account beneficiary.
• Most states require a small minimum investment to open an account (in California, it's $25). There are also maximum amounts - as high as $250,000 - that can be contributed for any one beneficiary. You can contribute through payroll deductions.
• Several people can open accounts for the same beneficiary. For example, a grandfather, grandmother, aunt, and uncle and even a friend could each open a separate account for one child - as long as the combined amount does not exceed the plan's maximum level.
• If money in a 529 plan account is not used for college expenses, the earnings are subject to taxes. With limited exceptions, a 10% penalty also applies if money is withdrawn and not used for college expenses.
• One exception to the 10% penalty occurs when the beneficiary receives a scholarship and does not need money in the account. Then the money may be withdrawn without penalty - up to the amount received from the scholarship. Taxes, of course, will be owed on the earnings.
• As the account owner, you may change beneficiaries. If your granddaughter, for instance, decides not to attend college, you can name another family member from a long list of  relatives that includes step-brothers, step-sisters, and cousins.
• You can designate a successor to be the account owner should you die before the beneficiary uses the funds for college.

Funds in a 529 account remain under your control - even though your grandchild is the account's beneficiary. If you need the funds, you can withdraw money for your personal use, paying taxes and a 10% penalty on any earnings.

Estate and Gift Taxes
Although you as the grandparent are the account owner when you invest in a 529 plan, funds in the account are (surprisingly) considered by the IRS to be out of your estate. So, any money you've invested in a 529 plan will not be included in your estate at your death for estate tax purposes.

Further, the IRS considers the money you invest in a 529 account to be a completed gift. This means that it qualifies for the $11,000 annual exclusion. Even better, the IRS allows you to accelerate up to five years worth of annual gift tax exclusions (or $55,000) into one year. Of course, if you do contribute $55,000 to a 529 plan for a beneficiary, you will have exhausted your annual exclusions regarding that beneficiary for five years.

Medi-Cal Treatment
Since you are the account owner, your 529 plan assets would be counted in determining your eligibility for Medi-Cal nursing home assistance. Worst case, you might need to withdraw and spend  the 529 plan account, and pay the taxes and 10% penalty on withdrawn earnings.

Investment Options
Each state's 529 plan offers a menu of investment options, with some states having many choices and others having only a few. The investment choices are typically conservative ones, with many states offering plans in which the investments are gradually shifted toward shorter term bonds as the beneficiary nears college age (when the funds will be needed).

Most states hire a professional asset manager to direct the investments. California uses TIAA-CREF, the large teachers' pension fund manager. There are five investment options in California's plan, which is called Golden State ScholarShare (go to http://www.scholarshare.com).

Student Aid Considerations
Will the funds in the 529 plan restrict your grandchild's opportunity to receive financial aid from a college? Possibly, although it is less likely when a grandparent is the account owner. Financial need is usually determined based on the student's and the parents' assets and income - but not the grandparents'. Once the student begins to receive distributions from the plan, a portion of this income may be included in the financial need calculations.

Additional Information
See the web site of Joseph Hurley [http://www.savingforcollege.com]. A CPA, Hurley is a recognized authority on 529 plans, and his web site describes and rates each state's plan. He gives five caps to the best state plans (California is rated four caps). This site also has information on 529 plans in general and the related tax issues. Mr. Hurley wrote The Best Way to Save for College: A Complete Guide to 529 Plans, available in many libraries.