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Why Start College Savings a Generation in Advance?

MP900442227Mighty oaks grow from little acorns, and a 529 you start for your someday-grandchild will also grow mighty with the benefit of decades.

It sounds a little extreme, but when you think about the power of compounding returns, starting a college fund for a grandchild while your own children are still young makes a lot of sense. According to Kiplinger in “529 College Savings Plans for the Unborn,” starting a 529 account for a grandchild before your own kids have kids or are even married, gives you years of growth and some tax advantages.

Think of it this way: thirty years ago, the annual out-of-state cost of a state university was about $5,000. Today, one year at an out-of-state university could easily cost $40,000 or more. Therefore, it makes sense to consider funding a 529 college savings plan for your grandchildren now.

The real advantage of a 529 savings plan is that the money they don’t use for college will continue to grow tax-deferred and can be used for their own children just by changing the beneficiary. The grandparent still has ownership of the account, meaning they won't spend the money on something other than college.

If you need access to those funds, the earnings (not the contributions) are subject to federal and state income taxes and a 10% federal penalty. Money in 529 college savings plans grows free of state and federal taxes, and if/when it’s withdrawn and used for qualified higher-education expenses, it will also be tax-free.

There are no maximum annual contribution limits.  However, there can be gift tax consequences if you give more than $14,000 per year or $28,000 for couples. The account can be front-loaded, up to $70,000 ($140,000 for couples) in a single year without gift taxes, if you don’t make any other gifts to the beneficiary that year or for the next four years. Money can be contributed until it reaches the limit, which varies by state.

If your daughter or granddaughter has graduated from college and is single, instead of waiting until you pass away to give her money as an inheritance, you might start a 529 college savings program (or keep hers if you still have it) with you as the owner and your daughter or granddaughter as the beneficiary and successor owner.

If you pass away before all this happens, designating your child or grandchild as the successor owner allows him or her to take over the account with their own child as the beneficiary. The beneficiary can be changed to another family member if the initial beneficiary chooses not to attend college.

This strategy offers great tax efficiency. Deposited funds are never taxed, as long as they are used for qualified expenses. You have complete control over the money during your lifetime and the plan beneficiary can use the money for any college they chose. The beneficiary can also be changed to another family member. Depending on your state, you may even get a tax deduction for your contribution to the account. This is a legacy your children and grandchildren will be thankful for!

Reference: Kiplinger (March 2017) “529 College Savings Plans for the Unborn”