College savings accounts authorized by Section 529 of the Internal Revenue Code are interesting little beasts. They can have tax advantages, but the creator of the plan maintains control without subjecting them to being seized by creditors. So, 529 Plans can be highly advantageous for some. If you are worried about debts or liabilities and have money in investment or bank accounts, a 529 Plan can be worth considering.
First, the taxes. 529 plans are taxed similar to Roth IRAs, meaning contributions are not deductible, but income and capital gains are not taxed as long as the funds remain in the account. Also like Roths, withdrawals from a 529 plan to a qualified person and purpose are not taxable income. The “qualified person” is the individual named as the beneficiary in the 529 plan documents, usually a child or grandchild. The “qualified purpose” is educational expenses.
Does that mean the money belongs to the child or grandchild? No. The owner of the 529 plan is the person who established it. The plan should also name a successor owner, thus, the plan does not terminate when the owner passes away. The beneficiary of the plan can also be changed by the owner or successor owner; therefore, the plan does not belong to the beneficiary. Unlike a trust, the beneficiary cannot demand a distribution from the plan. Because the beneficiary can be changed, that eases the worry that the beneficiary will not need the funds and the funds will be wasted.
So, creating a 529 Plan is not the same as giving away the money in a trust or a custodial account. If need be, the owner of the plan can use those funds for themselves, subject unfortunately, to a penalty. But because those funds have grown tax free, the gains may exceed the penalty. But here is the big advantage for some: the 529 plan is exempt from execution by your creditors. Like your homestead, it is an exempt asset. So, a 529 plan can be an excellent way to shelter assets that might be used by the next generation.
Section 529 plans can be an excellent part of the financial planning for your family. We make no specific recommendations about any investments, but we can refer you to financial professionals who can give you expert advice whether 529 plans are right for your family.
David M. Pyke
This material has been prepared for informational purposes only, and is not intended to provide, and should not be relied on for, specific tax, legal or accounting advice. We can only give specific advice upon consulting directly with you and reviewing your exact situation.
