529 Plans: An update
As we approach the end of the year, we are often asked what parents and grandparents can do to help their offspring and mitigate potential estate tax. One such option is setting up a 529 Plan for children or grandchildren. This option is also open to godparents and friends of the family.
529 Plans were established in the United States in 1996 to encourage families to save for increasingly expensive college educations. The growth in the investments is not taxed if they are used to fund qualified university expenses, including tuition, computer, room and board.
According to the College Board “Trends in College Pricing – 2014”, the average tuition and room and board at a public university is currently $18,689 for an in-state student per academic year. For an out of state student, this rises to $32,762. If attending a private college or university, the average is currently $42,419. This year is the first year since the 1974-75 academic year that tuition increases in the state sector rose below 3% on average.
Anyone who resides in the USA and has a social security number can establish a 529 Account for a family member or friend who has a social security number and will be attending a US or approved foreign university in the future. While it is in theory possible for an overseas based US citizen (who has a US address for this purpose) to set up such an account, it often does not always make sense from a local tax perspective (for example, the tax free investment growth may not be recognised and be subject to capital gains tax).
As an example, John and Jessica Smith, who live in North Carolina, are in their 60s and are looking to help their grandchildren with their college expenses. They can each give up to $14,000 to each of their grandchildren every year and reduce their US taxable estate. They are concerned that if they make a direct gift to the children, they will lose control over how the funds are used in the future. With a 529 Plan they retain control over the account and can withdraw funds subject to a 10% penalty if they are not used for educational purposes.
The Smiths may also get a state tax deduction on part of their gift, depending on where they live.
Fritz Wolf is 12 and his sister, Magda is 8. They live in London with their German father and their American mother Susan who is the eldest daughter of the Smiths. The Smiths could gift $28,000 to a 529 Plan they establish for Fritz for each year until he starts college, giving him a “pot” of $168,000. In fairness, they may give Magda the same amount but as she is younger her college “pot” should grow for an additional 4 years beyond Fritz’s.
The Smiths also have the possibility of accelerating their gifts by making 5 years’ worth of gifts when establishing the 529 Plan. This would represent a gift of $140,000 to each grandchild. Provided the Smiths live for five years after the gifts are made, the gifts would be excluded from their taxable US estates.
What if Fritz decides to go to university in Germany and uses none or only part of his 529 “pot”? The Smiths can either withdraw the excess funds – paying the 10% penalty or change the beneficiary to Magda or another grandchild or relative.
Anyone considering establishing a 529 Plan should consult their accountant and a suitably qualified financial advisor on whether such a course is suitable for them.
Tax advice is not regulated by the Financial Conduct Authority. Tanager Wealth Management LLP does not provide tax advice.