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Saving for College: Muddy 529 Plan Waters

There is a reason why the 529 Plan is considered the gold standard in saving for college: it represents the ability to put in after tax money into an account that grows tax free so long as the benefit uses the proceeds for qualified tuition expenses. All the earnings and capital gains are tax free, which, if started early can add up. States get to set the caps on their 529 plans. The caps range from $235,000 all the way to over $400,000. Once the benefit account has   reached   these   numbers,   no additional contributions are allowed in that plan, although it can still grow with the market.

There are two important people in a 529 Account: 1. An owner, 2. A beneficiary. The owner has the power to pull money, make distributions, and change the beneficiary (subject to some limitations). The beneficiary really has no rights. What is important to know is that if you want to change beneficiary the successor beneficiary must be a qualifying relative of the owner. There is an IRS publication that details who counts as a qualifying relative, which is a rather long list.

Since 529 plans are run by the individual states, there are costs attached to each individual plan, as well as varying investment options. It is important that you understand these costs, and talk to an advisor about what plan is right for you. Lastly, should the money not be used for education, the earnings are taxed at ordinary rates, and are subject to a 10% penalty.

In a custodial account the child is the technical owner of the account. The name and social security number are on the tax records that get reported to the IRS. The guardian, typically also the custodian, is supposed to act in the child’s best interest. Since the account legally belongs to the child, the guardian cannot use those assets to pay for things that they themselves are legally obligated to pay for (e.g., food, water, etc.).

Taxes can also be more complicated with a custodial account. Dividends and interest are taxed at ordinary rates, except where the dividends are considered qualified. When securities are sold there is either capital gain or loss associated with that sale. All of the income is placed on to the child’s tax return. The issue is that often times the child gets taxed at their parent’s rate for some of that income, which is commonly referred to as the Kiddie Tax.

The major benefit of a custodial account is that the money can be used for virtually anything. If the child does not go to college, they can use the money as a down payment on a house, or car. But that is also a downside. Once a child turns a certain age (at most 25), the custodian has to turn over the control of the account to the child. At that point the child can choose to do with the money as they please.

The information herein is general in nature and should not be considered tax advice. Please be sure to call us or consult with a tax professional for additional information. Werba Rubin Wealth Management, LLC (“Werba Rubin”) is an investment adviser registered with the Securities and Exchange Commission. Securities transactions are offered through a non-affiliate entity, Loring Ward Securities Inc., member FINRA/SIPC. IRN WR 15-022 (08/17)