Plus, custodial accounts, trusts, and more.
College-savings expert Susan Bart answers advisors' questions on 529 plans and other education-planning matters. E-mail your questions to firstname.lastname@example.org.
Question: As parents, we have $28,000 in a 529 plan for a 16-year-old child and $28,000 in a 529 plan for a 12-year-old child. We also have a small LLC business. I understand that only about 5% of this money is considered in the financial aid calculation (Expected Family Contribution) on FAFSA because the account owner is the parent. Should I file the Account Owner change form with my state 529 plan to make the LLC the account owner of these accounts so none of it shows up on FAFSA, and if so, what are the tax consequences of the transfer? Any other tips or related ideas?
Susan: I advise clients to play it straight. As you noted, the result for financial aid purposes is favorable because the 529 savings accounts will be treated as assets of the parents and not as assets of the student. Further, changing the account owner to your LLC would increase the value of the LLC, possibly affecting the financial aid calculation. In addition, the financial aid officer would have discretion to disregard the change of account owner. And there might be other consequences, such as exposing the 529 assets to the creditors of your business. Be content with a good result, even if you could imagine a better one.
Question: A friend's brother recently passed away leaving a 9-year-old child and wife surviving. We are concerned that the mother will spend any remaining funds, leaving nothing for the child's education. We are considering having a fund-raiser to solicit contributions in order to create a 529 plan for the child and expect we could raise $40,000 - $50,000, but are looking for the most efficient way to accomplish this. Do you have any recommendations? We prefer not to use a trust.
Susan: The primary issue is whom do you trust to be the account owner, knowing that the account owner has no fiduciary duties to the designated beneficiary? Even if you trust your friend enough to serve in that role, do you trust whomever he may name as a successor account owner?
One possibility might be to establish the 529 savings account as a custodial account under the Uniform Transfers to Minors Act. The program should (but check the program description) prohibit the account owner of a custodial 529 account from distributing the funds to herself or from changing the beneficiary. Further, the program should require that the beneficiary become the account owner at age 21 (or the appropriate age under the Uniform Transfers to Minors Act), ensuring that the funds go to the beneficiary (but not necessarily ensuring that they are used for education).
Question: If parents set up 529 plans with their children as beneficiaries and later divorce or separate, would moving the ownership of the plans into a trust help to 1) ensure that the funds are only used for the purpose described and 2) prevent one parent or the other (the account owner) from taking nonqualified distributions for themselves or for other purposes?
Susan: Yes, a trust could help ensure that the 529 funds are used only for their intended purpose. Both parents might establish one trust for all of their children and the trust could contain provisions addressing how the trust assets should be used (e.g., for the children's college and graduate school education), how the trust benefits should be allocated among the beneficiaries (e.g., can a child use more than her pro rata share of trust assets for a more expensive education), when the trust should be terminated (defining when the children shall be deemed to have completed their education can be tricky), and how the trust assets should be distributed when terminated (e.g., equally to the children even if some of them received more expensive educations). The parents jointly could act as trustee or a third party (perhaps an aunt or uncle of the children) could act as trustee.