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Beneficiary in the Dark on 529 Account

Plus questions about distributions when tuition is otherwise covered, when computer expenses qualify, and more.

Susan T. Bart, 07/29/2011

Question 1: My great grandparents set up an EdVest account for me to use to go to school, but since my great grandfather passed away, my grandfather has been given power of attorney and will not communicate to me about the account. I have already used some of the funds but have not been able to obtain an account history or any more information regarding this fund. Is there anything I can do to get this information? I am 21 years old and currently enrolled in college. I suspect that my grandfather is draining the account as he did with my mother's and aunt's, and when I called EdVest, the only information they would give me is that my social security number is linked to an account owned by my great grandmother.

Answer: If your great grandmother is the account owner, she controls the account and your grandfather should not have any power over the account unless she gave it to him. You should talk to your great grandmother and make sure she understands what she needs to do to make sure your education expenses continue to be paid.
If she gave your grandfather power over the account and she is still competent, she can take away that power and put someone else in place who will make certain the funds are used for your education. She should also designate a successor account owner in the event of her death who will make certain the funds are used for their intended purpose.

Question 2: I have a new and rather wealthy client who set up 529 plans a few years ago for his children, who are now in college. I told him he should pay the college tuition to the school from his own funds to reduce his estate, and we could consider starting to pay the funds in the 529 plans out to his children now, as they are in low tax brackets, or else keep them in place as "retirement" plans for the children (to avoid paying the 10% penalty any earlier than we have to).

I had always assumed that if the parents paid the school directly, any distributions made to the children from the 529 plan could not be income-tax free. However, the IRS Publication 970 on page 55 indicates that the parents' "gifts" to a child will be ignored and, in fact, the 529 distributions could remain tax free, at least in part. The Publication involves what looks like a cash gift from the parents to the child, and not the parents' direct payment of schooling costs, which is a non-gift, but it is not clear that that distinction is meaningful.

So perhaps the 529 plans can distribute funds each year to each child equal to such child's college expenses (but which the child would keep, as the parents already paid the bills) and have the earnings be tax and penalty free?

Answer: Fascinating question. Code section 529 does not actually trace the use of the funds distributed from the 529 account but rather merely compares adjusted qualified education expenses with the amount withdrawn. Publication 970 states:

To determine if total distributions for the year are more or less than the amount of qualified education expenses, you must compare the total of all QTP distributions for the tax year to the adjusted qualified education expenses.

Adjusted qualified education expenses. This amount is the total qualified education expenses reduced by any tax-free educational assistance. Tax-free educational assistance includes:

Susan T. Bart is a partner in the Private Clients, Trusts & Estates Group at Sidley Austin LLP in its Chicago office, where her practice includes estate planning, estate and trust administration, and fiduciary counsel. She has written two books, including Education Planning and Gifts to Minors published by Illinois Institute for Continuing Legal Education (iicle.com), which extensively discusses 529 plans.

She is the author of Education Planning and Gifts to Minors 2004 Edition. She is a frequent speaker on trust and estate topics in general and Section 529 college savings plans in particular.

The author is not an employee of Morningstar, Inc. The views expressed in this article are the author's. They do not necessarily reflect the views of Morningstar. The author is a freelance contributor to MorningstarAdvisor.com. The views expressed in this article may or may not reflect the views of Morningstar.

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