If you were thinking ahead, you may have set up a tax-advantaged Section 529 plan for your first child at an early age. Once your kid is ready for college, you’ll reap the rewards of your foresight.
But what happens when your son or daughter graduates? If there’s still money in the plan, your tax savings don’t have to stop there. If you have other children, you could designate one of them to be next in line as the 529 plan beneficiary, and then choose another and another… possibly even extending the plan’s benefits to your grandchildren!
Section 529 plans, sponsored and operated by individual states, encourage families to set aside funds for future education expenses of the younger generation. As long as certain requirements are met, the money invested in the plan can grow without any erosion by taxes; and distributions that go to pay qualified college expenses—including tuition, fees, books, supplies, equipment, and room and board for full-time students—are completely tax-free.
There are two main types of plans: prepaid tuition plans and college savings plans. A prepaid tuition plan enables you to lock in rates at an in-state public college, whereas a college savings plan gives you more flexibility—the money can be used at a public or private college of your choice—but doesn’t offer guarantees.
Keep in mind that it doesn’t matter which state’s college savings plan you choose, because no matter where it’s set up, you can choose where to spend money from the account. But there could be an advantage to using your home state’s plan. More than half of the 50 states offer a state tax deduction or credit for Section 529 plan deposits made by residents.
Now suppose your daughter is finishing college and your son is poised to attend next fall. Assuming some funds are left in the account, you can simply switch the beneficiary designation for the 529 plan to the younger child. Typically, a plan will allow one such change each year. If a younger child will enter college before the older one graduates, you might want to set up a separate account.
Although a plan can continue indefinitely, with your grandchildren eventually becoming beneficiaries, it terminates when the latest beneficiary reaches age 30. Of course, if there’s a gap—say, your youngest child turns 30 and you have no grandchildren—you still can set up a new plan for a grandchild in the future.
A final bonus: There’s a special gift tax break for 529 plans. Not only are transfers to 529s considered gifts that qualify for the annual gift tax exclusion ($14,000 in 2017), you can make up to five years worth of contributions in one year. And your spouse can do the same. Together, you could transfer up to $140,000 into a child’s or grandchild’s 529 entirely exempt from gift tax.
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