With multiple 529s, which to spend first?

By: Savingforcollege.com

Q:

Dear Joe, My child's grandmother and great aunt each have a 529 plan for her college expenses. What expenses for college are covered and what paperwork (receipts) do we need to record or keep? Is it going to be a problem having two 529 accounts? -- Roxanne

A:

Dear Roxanne,

It's fairly common for multiple family members to set up their own 529 plans for a particular child. Parents, both sets of grandparents, and aunts and uncles may all have a desire to help pay for the child's college education.

By retaining ownership of their own 529 accounts -- as opposed to making contributions to your parent-owned account, the other family members remain in control of their college investments. They have the right to change the beneficiary designation to a different family member, and they can even decide to pull the money back out for themselves, subject, of course, to tax and a 10 percent penalty on any distributed earnings.

In your situation, the problem comes down the road when your child enters college, and the 529 funds are needed to pay her expenses. Whose money is to be used first, grandma's or auntie's?

Quite possibly, it will be up to you as gatekeeper to make that decision. You could invite one to pay for tuition and fees, and the other to pay for books, supplies and room and board. Or perhaps, one will help fund freshman and junior years, and the other will fund sophomore and senior years. Of course, the decision must be based in part on the total amount of money in their respective accounts, and how that total compares to your child's qualifying college costs.

Account owners can request that the 529 plan make distributions payable to the school, to your child as beneficiary or to themselves as reimbursement for costs they pay using other funds. Typically, I recommend making the distribution payable to the beneficiary who can then use that money to pay his or her expenses. This approach often helps to avoid certain tax and financial-aid complications.

You do not have to trace the distributions directly to the payment of qualified higher education expenses such as tuition, fees, books, supplies, equipment, and room and board. As long as total qualified expenses paid during the year equal or exceed the total distributions for the same calendar year, the distributions are tax-free and do not have to be reported on the recipient's income tax return. But you will need to retain receipts as evidence of those payments in the event of an IRS examination.

At some point, your daughter's grandmother and great aunt may decide they no longer want to be account owners and will request that the 529 plan administrators transfer ownership to you. This can certainly make your job easier when it comes time to tap those accounts, since you will then have total control. Beware: A few 529 plans do not accept requests to transfer ownership. The only way to accomplish it may be to roll it into a more accommodating 529 plan first.

Popular Questions

Question

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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