A 529 plan is a college savings plan usually run by an individual state. There are also independent plans and plans run by educational institutions (which can only be the pre-paid tuition type.) As a general rule, you can get a state tax deduction for contributions, the money grows tax-free, and then if used on approved educational expenses, is not taxed when it is pulled out. A 529 plan should be the mainstay of the college savings plan for the children of most physicians.
But who should own the plan? The beneficiary is the child, of course, and that can be changed if the kid decides to spend his 20s smoking meth instead of going to law school. But there are several different options you can use as the owner. Let’s take a look at them one at a time:
The Child as Owner
You can actually contribute to your own 529. So the beneficiary and the owner can be one and the same. There are four significant downsides to this approach. The first is that the parent loses control of the money. The above-mentioned drug addict can take all that money, pay the taxes and penalties, and give it to his toothless honey. The second is that it counts against the child in financial aid formulas. Your child may still have “financial need” to pay part of the costs of education. Remember the FAFSA? On the day you fill that out, 5.6% of the value of the 529 plan will be deducted from the child’s financial need. That means fewer grants, loans, scholarships etc. Distributions from the plan (which of course you’re going to have to take) actually reduce “financial need” dollar for dollar. Third, the person who owns the account gets to take the state tax deduction. In most cases, that’s going to be a lot more valuable to you than to your child. Last, in my plan (and I suspect most plans), you have to be 18 to open an account. That’s a little late to be saving for college.
The Parent as Owner
This is probably the most common set-up, and what I’m currently doing for my childrens’ 529s. Parental ownership is exactly the same as child ownership from the perspective of the FAFSA and your expected financial contribution (EFC). The EFC is reduced by 5.6% of the amount in the 529 and 100% of the distributions. However, I get control over the money and can change the beneficiary as needed. I also get the state tax deduction, which for my 3 kids in Utah is worth up to $500 a year.
The Grandparent as Owner
Lots of financial advisers recommend the grandparent own the 529. The main benefit is that the EFC isn’t reduced by 5.6% of the amount in the 529. The distributions still count against the child, but you can delay those until later in college (i.e.wait until the senior year to do the 529 withdrawals, using loans or other resources until that time.) This approach allows the grandparent to have control, which is fine if they’re the ones contributing the money, but perhaps not so fine if you’re giving them the money to contribute. The grandparent’s contributions, of course, reduce the size of their estate which may have some beneficial estate planning effects for them.
Corporation as Owner
You can even form a corporation to make contributions, or make contributions directly from your professional corporation. There’s no real tax benefit there. You’re better off hiring the kid as an employee of the corporation. Then up to $5,250 a year can be paid pre-tax toward the costs of that employee’s education.
Trust as Owner
529s can even be opened by a trust. There are some benefits to doing this, primarily flexibility in the event of your death, but there are some downsides too (like being unable to put 5 years worth of contributions in at once). The trust’s assets, whether in a 529 or not, are counted toward the EFC at the same rate.
Which should you choose?
If you don’t expect your child to need (or qualify for) any financial aid, then go ahead and own the thing yourself. There really is no downside in this situation. If you expect to only pay part of the cost of his education, you should seriously consider making a grandparent or other trusted friend or relative the owner. But trusted is key. Remember that the grandparent can always take the money out, pay taxes and the 10% penalty on earnings, and stuff it into slot machines on The Strip.
Image Credit, Johntex, via wikimedia, CC-SA