Protecting grandchildren's 529 plans



Dear Joe, I have approximately $150,000 for investment in 529 plans for three of my grandchildren, ages 3, 5 and 7. As I understand it, I will be the donor and can name myself as the custodian. However, since I am 80 years old, the funds will be in the custody of a successor custodian for most of the time. My question is: What is there to stop the successor custodian from withdrawing funds before the children reach their adulthood (and) to use them for her own purposes rather than for the children's higher education? -- Barney


Dear Barney,

Your concern is valid. Upon your death, the successor account owner -- in your words, the successor "custodian" -- takes over. And just as you have the right to change the 529 account beneficiary, to decide when and for what purpose to take withdrawals during your lifetime, and even to take the money back for yourself, the named successor steps into these rights if you were to pass away with assets still remaining in your 529 accounts.

Tax penalties and moral obligations aside, there are ways for you to safeguard the ultimate use of the 529 plans for your grandchildren. One of these is to name the grandchild -- and not the parent or other individual -- as successor owner of his or her 529 account. The 529 plan administrator still will require that the minor's parent or legal guardian be named as custodian, but the advantage is the custodian now has a legal obligation to use the 529 account for the benefit of the named beneficiary and for that child only. When the child reaches adulthood, the custodianship terminates, and the account can be retitled in the child's direct name.

A disadvantage to this approach is that it removes the successor owner's flexibility to shift 529 assets between the three grandchildren or to future grandchildren based on their individual college funding needs. Another potential disadvantage is, upon reaching the age of adulthood, the child may decide to take the 529 funds and use them for noneducational purposes, even when doing so will give rise to taxes and a 10-percent penalty on any gains.

Alternatively, you could ask your attorney to help you put together a trust to hold the 529 assets. The trustee would have a duty under the terms of the trust to use the money in the way you intended. Naturally, there are legal and accounting costs in establishing and maintaining a trust. But with a large sum of money going into 529 plans for your grandchildren, the added expense may be justified. Just be sure you engage an attorney who is familiar with 529 plans and the special rules involving gift taxes and distributions.


Popular Questions


Two kids, two 529 plans?

Dear Big Bill,
While it's possible to maintain a 529 plan in just one child's name, even when you intend to send more than one child to college, I generally recommend that families open a separate 529 account for each child.

That's assuming there is no additional cost to maintaining multiple accounts. If your 529 plan charges an annual or quarterly account maintenance fee, check to see if you can avoid the fee by signing up for automatic contributions through payroll deduction or electronic funds transfer)

With a separate 529 plan for each child, it becomes easier for you to tailor the mix of stocks, bonds and stable-principal investments (e.g., stable value, guaranteed principal and money market funds) to the particular ages of your children. When your older child is nearing high school graduation, you may want to ratchet down the level of market risk in her 529 plan. At the same time, you could keep a more-aggressive asset allocation in your younger child's 529 plan, accepting more risk for a potentially higher return. Many 529 plans offer "age-based" investment options that automatically make these adjustments as the beneficiary ages.

Separate accounts for your children also offer more gift-tax leeway. Since your 529 contributions are treated as gifts from you to the account beneficiary, your $15,000 (in 2018) annual gift exclusion will go twice as far with two accounts -- one for each child -- than with just one account.

Financial aid is another reason to recommend maintaining separate accounts. You wouldn't want the investments reserved for your younger child's future college expenses to count against your older child's financial aid eligibility. Be warned: The rules here are rather murky, and the impact of a sibling's 529 account may depend on the college's own policies as well on as the type of aid -- federal or institutional -- being sought.

Finally, I believe that separate 529 accounts allow for better family bookkeeping. There will never be any doubt as to your intention to help send all of your children to college. You'll avoid the uncomfortable position of being asked to explain to a curious 8th-grader why account statements are showing up in the mail with only a brother or sister's name on them. And in the event of your death or divorce, no matter how unlikely, your legal representatives and other family members will have less reason to question your actions in setting up and funding the 529 plans.

Even with separate accounts, you'll continue to have the flexibility to shift the money around in the future. You simply need to make sure that whenever funds are withdrawn from the 529 plan to pay for college they are coming from an account in the name of the child incurring the costs. It's a simple matter to change the beneficiary designation among family members at any time, transfer 529 funds between different family members' accounts or split one 529 account into two. The ability to move assets around the family is a key advantage of 529 plans when comparing other college-savings alternatives, such as Uniform Transfers to Minors Act, or UTMA, accounts.

Original Post: 2005-10-13
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Coverdell ESA vs. 529 Plan: Which to choose? (Script)

The Coverdell ESA and the 529 plan are both excellent college savings vehicles because they are both tax-free when used for college. But many families face a choice: do they use a 529 plan for all of their child's college savings, or do they use a Coverdell for the maximum amount of $2,000 each year and put any any extra savings above $2,000 into a 529 plan? In spite of its low annual contribution cap, Coverdell's are now attracting quite a few families. There are two major reasons for that. One is that only the Coverdell allows you to self-direct your investments, just like you might self-direct the investments in your IRA. The other is that in addition to college expenses, Coverdells can be withdrawn tax-free to pay for a broad range of K-12 expenses, while 529 plans are limited to K-12 tuition. This feature is appreciated most in families planning to send their children to private grade schools, which may include additional costs such as room and board or uniforms. A 529 plan, on the other hand, does not impose age limits or income limits like the Coverdell does and so overall we see a lot more money going into 529 plans than into Coverdells. Plus many savers are happy with the investment choices offered by the 529 plans and don't necessarily want to self-direct their investments. And don’t forget this: your state may be giving you a state tax deduction for using a 529 plan, but there are no states offering a state tax deduction for investing with a Coverdell ESA.

Learn more about Coverdell ESAs.

Original post date 2013-07-15
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Top 529 Plan Withdrawal Tips. (Script)

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Top 529 Plan Withdrawal Tips. (Video)

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