Can your 529 plan last forever

When you think you know about a 529, you learn that you might not have even considered the the idea of your 529 lasting forever.

Readers again wrote in with questions on how to maximize college savings, including on how best to use “529” accounts, the federal tax-advantaged college-expenses accounts that invest in mutual funds. We asked experts to help answer their questions.Can a 529 last indefinitely, for multiple generations of a family? What are the tax consequences of changing the beneficiary to future generations? Yes, but not in a completely tax-free manner. You can switch the beneficiary of a 529 without any penalties, as long as the new beneficiary is a relative of the original beneficiary (see IRS Publication 970 for the complete list of which family members qualify). And the account can be used for only one beneficiary at time. “Once you’ve paid for the original beneficiary’s education, the remaining funds could be used toward education costs for a younger sibling, niece or nephew, aunt or uncle, or even a parent,” says Tom Rowley, director of retirement and education strategies at Invesco.

To front-load a 529 so it has enough money to last for many years, you can contribute as much as five times the annual gift allowance ($14,000 for individuals, $28,000 for couples) per beneficiary in a single year without triggering gift-tax reporting, as long as you make that your only gift to that beneficiary in the following four years, says Susie Bauer, a senior vice president at wealth manager Robert W. Baird for 529s and unit investment trusts. That means your $70,000 contribution ($140,000 for a couple) is considered as taking place over a five-year period for gift-tax reporting purposes, she says.

Be careful how you’re investing the funds in your 529 if you want it to serve multiple generations. When you use one account for multiple family members, changing the beneficiary to whichever relative is headed off to college or graduate school, the account may be invested in funds that aren’t optimal for withdrawing money at a specific time, Mr. Rowley says.

“When the same account is used for multiple people, it can be harder to tailor your savings time frame and risk tolerance to your family’s unique needs,” he says. Pay attention to the tax ramifications of switching the beneficiary, Mr. Rowley says: “Things do get more complicated when you skip generations and the federal generation-skipping tax comes into play.”Changing the beneficiary on the account to a relative in a younger generation is treated as a gift from the current beneficiary for the purposes of gift taxes. This could cause problems.

“Since the beneficiary never has control of the 529 assets and may not even know the account exists, you could inadvertently affect their lifetime gift-tax exemption, which is the total amount that an individual can be given by another individual over his or her entire lifetime free from gift taxes,” Ms. Bauer warns. In addition, a person making contributions in excess of the annual gift exclusion needs to elect the five-year gift averaging on IRS form 709, she says.***

Can I open a 529 in my own name and distribute funds as needed for qualified expenses to my family members instead of opening individual accounts?

No. “529 funds can only be used by the designated beneficiary, which means you cannot designate funds from a single account to multiple relatives at the same time,” Mr. Rowley says. However, you can switch beneficiaries once you have paid for some or all of one person’s education. You can also create a new account with the same beneficiary, roll over some of the funds from the existing account to the new one and switch the new account’s beneficiary to any relative of the original beneficiary. If you use money designated for one person to pay for another’s education expenses, you’ll be subject to income tax and the 10% penalty on the earnings portion of your withdrawal, Ms. Bauer says. ***

We have money left over in our son’s 529 after he won a scholarship for his bachelor’s degree. If he attends grad school later, his employer is likely to subsidize the tuition. I know that if we withdraw the money, we’ll owe federal taxes and the 10% penalty. What other options do we have?

“The great thing about 529 plans is that as the account owner, you retain control of the assets—which means you can choose a new beneficiary at any time,” Mr. Rowley says. This includes any relative of your son’s, or even yourself. You can also leave the money in the account in anticipation of future educational expenses in the family. Remember, you don’t have to be pursuing a degree to use a 529. “The course just needs to be offered by an eligible institution, which means that the school has a federal financial-aid code,” Ms. Bauer says. (You can look up schools on the Fafsa website). Note that if you had chosen to withdraw the equivalent amount of the scholarship your son received in the year he received it, that distribution would have been penalty-free; you would have paid only income taxes on the earnings portion of the withdrawal.

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