529 Plans for Americans Living in the UK
Planning for children’s education is an important issue for most parents since quality education is a critical part of a child’s life and a significant factor in their personal growth and future success. However, it can also be a considerable expense. The cost of private schooling and university has been growing faster than inflation for decades. The average price for private school fees in the UK is now £14,289 a year (and considerably more in London), while average tuition at a private American college currently stands at $36,801 a year. With costs this high, it is essential to plan and start saving early. There exist various tax-efficient saving and investment options designed specifically for education planning that offer multiple advantages to families trying to save for their children’s educations. Unfortunately, for US citizens living in the UK, these “tax-advantaged” accounts pose several potential problems.
The most common tax-advantaged account in the United States is a 529 College Savings Plan (“529 plan”). Originally introduced in 2001, 529 plans allow parents, grandparents, and extended friends and family to contribute to an account for a child’s educational expenses. The investment enjoys tax-deferred growth while it is in the plan. Additionally, distributions can be taken from the account without incurring any taxes, as long as they are used to pay for ‘qualifying educational expenses,’ such as tuition, books, or room and board. Therefore, if the money is used to pay for qualifying costs, the account will be effectively tax-free.
While these tax advantages make 529 plans very appealing to individuals living in the USA, those benefits are unfortunately not recognised by the HMRC. US citizens who live in the UK need to be careful with 529 plans that have set up for their children’s education before relocating to the UK, or that may be set up by relatives for the children’s benefit.
529 plans are structured as trusts in the USA, not as individual accounts owned directly by the taxpayer. As a result, the UK considers 529 plans to be foreign trusts, rather than investment accounts. As trusts, 529 plans would not benefit from any tax benefits in the UK. In fact, they could create additional tax issues since the underlying investments will likely be subject to UK income tax, capital gains tax, and potentially even inheritance tax. Furthermore, the underlying investments in the fund will likely be taxed punitively in the UK, since they are offshore collective investments that don’t report to the HMRC. The advantages of 529 plans are lost once the plans are subject to tax considerations in the UK.
Factors such as how long the account owner has lived in the UK, how their taxes are filed in the UK, and when the 529 plan was established affect the nature of the tax burdens encountered by Americans.
If you have a 529 plan and are a long-term resident of the UK, you have a few options on how best to proceed, including keeping the plan, changing the owner of the plan, and distributing the assets. Each option comes with trade-offs and potentially taxes, and you should get quality advice before making any decision. The right choice depends on your family’s education goals and personal circumstances.
If you are considering a 529 plan for your educational savings strategy, be aware of the significant tax issues they can create in the UK. There are other options available, ranging from custodian accounts to trusts to brokerage accounts. The decision on what vehicle to use depends on your unique situation. Our cross border financial planning team is available to discuss your options with you, and we are happy to have a discussion with you on what might be the best approach for you.
As these are complicated tax matters, you should speak with a financial planner and an accountant to discuss your specific situation. Tanager Wealth Management does not provide tax advice, however we can introduce you to dual-qualified US/UK tax advisors as needed.