December 8, 2009
Who would have thought it would be so complicated to save for something as basic as your children’s education?
It isn’t a simple undertaking, and one of the biggest dilemmas parents face is whether to use a 529 plan for that purpose. The “Great Unwind” jolted many 529 college plan savers. Especially hard-hit were age-based 529 portfolios and self-managed plans that were still invested in equities for students in or very near college in 2008 or 2009. Many are reconsidering whether 529s are right for them, and others are approaching the decision for the first time.
When considering using a 529 plan, start with the end in mind. What are the primary goals in saving for college? Traditionally, they have been:
Goal #1: have the saved principal be secure
Goal #2: achieve some growth of principal after inflation
The recent market decline coupled with, tax, custodial, management fees and estate planning issues make the decision to use a 529 plan less than straightforward. Let’s briefly review the history of college savings plans and see how the current landscape favors 529s for some clients but not for others.
Years ago parents and grandparents salted away savings for college in an UTMA or UGMA. The accounts were probably in a bank savings account (remember the little passbooks the teller would stamp for us?), the taxes on earnings were negligible, if any (unless you were lucky and it was ’74-’82), and the capital gains tax was not much of an issue because the funds were invested in CD’s or r bank savings accounts.
Starting in 1999 the Federal Government created a series of vehicles to encourage more savings for post-high school education. The first was the Coverdell education saving account. 1 This provided a tax exemption for earnings and growth if the proceeds were used for specific educational purposes. It offered some estate tax sheltering and fuller parental/custodian control than a UGMA/UTMA. If the parent maintained control of a Coverdell, however, doing so nullified the potential financial aid advantages of having the child be the owner. Also with a Coverdell both the adjusted gross income (AGI) and the annual gift limits are too low for many clients.
In 2001, Congress passed the Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA), and with it the 529 plan came into prominence. The 529 improved on the Coverdell by removing AGI limits, meaningfully raising the annual gift amount, adding an estate tax sheltering election, and allowing transfers of funds among siblings. These enhancements afforded advantages over the potentially more costly approach of setting up individual trusts in order to retain parental control past the age of minority. Furthermore, trusts do not afford the potential tax exemption on income and growth of principal.
1 Surprisingly, Coverdell accounts are not universally available even at retail-oriented brokerage firms.
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