The stretch 529

http://www.savingforcollege.com/articles/the-stretch-529

Many legal and financial advisers have been helping their clients take advantage of the new ""minimum distribution requirements"" that permit longer payouts from IRAs. The idea of the ""Stretch IRA"" is to lengthen the payout period to include the lives of certain beneficiaries, thereby minimizing the annual taxable distribution and maximizing the deferral tax benefit. If it's stretch your client is looking for, he or she can find it in spades in the 529 plan. IRC section 529 neither mandates minimum distributions nor imposes time limits on the duration of the account. As long as the account has an individual beneficiary, it can remain intact. (Note, however, that certain states, such as Virginia, impose their own limits.) Because a beneficiary can be replaced with a descendent or certain other family members, you can almost always find a new replacement beneficiary if you desire to keep the account alive. Here's an example: James establishes a 529 plan for his son John and contributes $100,000. The account is never needed for John's college expenses and continues to grow to $300,000 by the time John's son Jerry is born. James decides to change the beneficiary of the 529 account from son John to grandson Jerry. Fifteen years later, James dies and account ownership is passed to son John. John's son Jerry ends up with a ""full ride"" at West Point Academy, so the 529 funds are not needed for his college expenses. Jerry later marries and has a child, Julius. John, as account owner, changes the beneficiary of the 529 account from Jerry to Julius. At this point, the account is worth $1.5 million. The upshot: James's initial $100,000 contribution has grown tax-deferred in the 529 account to $1.5 million, and no end is in sight. (Of course, by that time the $1.5 million value might also represent the four-year cost of a college degree.) However, for investors tempted to sock away large amounts of money in 529 plans for the long-term tax deferral opportunity, with little or no intent to target those savings for college, I suggest they think twice. This strategy can easily backfire, for any of the following reasons: When the account is distributed (eventually) for a non-qualifying purpose, the earnings are subject to tax at ordinary income rates plus 10%. The end result can be less favorable than an investment asset that appreciates over an equivalent period of time and qualifies for capital gains treatment when sold. The deferral benefit of a 529 plan loses its luster when the account is invested in a portfolio that is already tax-efficient. The 529 program administrators can terminate an account if they decide that the owner's main objective is something other than saving for the account beneficiary's future college expenses. And it could spoil things for many families if the IRS and/or Congress decide to impose new restrictions or penalties because they think that investors are abusing the power and flexibility of 529 plans. Unlike investment assets held directly, 529 accounts do not obtain a ""step-up"" in tax basis when the account owner dies. The entire amount of built-up earnings will be reported to the eventual distributee. Of course, the tax basis does not matter if the distribution qualifies for income exclusion. However, if the earnings are taxable, the lack of step-up could mean a much greater tax burden for the heir who receives 529 proceeds as opposed to non-529 investment securities. Finally, be aware of the potential gift tax consequences when the beneficiary of the 529 account is changed to a younger-generation family member in the move to keep the account alive. The entire value of the account, at that time, will be considered a gift from the former beneficiary to the new beneficiary. This result can create unexpected problems for the former beneficiary, especially if that former beneficiary is not prepared for the gift tax consequences. (It is conceivable that the original beneficiary will not even be aware of the transfer and deemed gift until the IRS comes along and assesses additional gift or estate taxes.) Nearly any 529 account has the potential to be a Stretch 529. The best strategy is to tap the account for qualified higher education expenses at the earliest possible opportunity. This follows the original intent of the law, and at least through the 2010 sunset, results in tax-free distributions. The account can be replenished with new contributions, subject to program contribution limits. The replacement contributions will boost the account's tax basis, reducing the potential for tax liability later on."