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Coordinating multiple college savings plans
My in-laws have set up a college trust for all of their grandchildren via a 529 savings plan in their home state of Illinois. I am now looking into savings options for my daughter and thinking about starting my own 529 savings plan, in New York, where we live. Is there a downside to having two 529 savings plans in two different states for the same children? Right now we only have one child, but we hope to have more in the future. Should I save money for my child in some other way since she already has a 529 savings plan from her grandparents? Thank you.
First let me congratulate you on having such thoughtful in-laws. I'm certain any financial assistance they wish to offer toward their grandchildren's college dreams, large or small will be gratefully accepted.
I see nothing wrong with opening your own 529 accounts in a state different from the state in which your in-laws opened theirs. As a New Yorker, you can benefit from a state income-tax deduction of up to $5,000 annually, $10,000 joint, for the contributions you make to New York's 529 plan. Similarly, your in-laws qualify for an Illinois state income-tax deduction of up to $10,000 annually per contributor for contributions made to the Illinois 529 plan. Twenty-six states and the District of Columbia have enacted a state income-tax deduction for contributions to the in-state 529 plan. These tax benefits can be an important factor in deciding whether to use your home-state 529 plan.
The biggest challenge you may face is the coordination of withdrawals once your child starts college. Do your in-laws intend to reimburse you for the expenses incurred? Or will they prefer to pay the bills directly from their 529 plan? The simplest approach might be for them to roll over their 529 funds into your 529 plan at the appropriate time and let you handle the withdrawals. (They are restricted to one tax-free rollover per beneficiary every 12 months.) You should speak with your in-laws as college gets closer to come up with a strategy that accomplishes their desires. Also make sure everyone understands how that strategy affects tax reporting responsibilities and your child's financial aid eligibility.
In the meantime, you should attempt to find out more about the 529 accounts set up by your in-laws. You mentioned a "college trust," but most 529 plans are established with an individual, not a trust, as the owner. What would happen if your in-laws were to pass away before your child graduates from college? Are you, your spouse or both named as successor owners of the account established for your child, or is there a trustee who will continue to control their 529 accounts?
It would also be helpful to know how much of your daughter's college expenses are going to be covered by her grandparents. This information will obviously affect your own college planning. You should avoid putting more money into a 529 plan than is going to be needed for college expenses. If it's removed for other purposes, the earnings portion becomes subject to income tax and 10 percent penalty. Understand, no one will be forcing you to liquidate an "overfunded" 529 plan. You can avoid the tax and penalty by retaining it for eventual use by other qualifying family members -- perhaps even a future grandchild of your own.
I think more grandparents should become familiar with 529 plans. I recall a survey done for Fidelity Investments suggesting that many would like nothing more than to help support their grandchildren's college dreams. Yet who could blame any grandparent for not incurring the legal and accounting fees necessary to form a family education trust, or for being reluctant to gift their money to a grandchild's custodial, or UTMA, account where they lose control over how that money is spent?
For some grandparents, the most-appealing aspect of a 529 plan is that they can continue to control the account even as the funds are no longer considered part of their taxable estates. They can make the investment choices; they can change beneficiary designations to other family members; they can even take the money back for themselves at any time subject to tax and penalty on the earnings. It could be just what they have been looking for.
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