When It Comes to 529 Plans, No Need to Share

Question: I have triplets who one day will be entering college at the same time. Can they all share a 529 account?

Answer: Parents of multiples often are accustomed to having them share things. Your kids may share a room, their toys, or their clothes. After all, why buy a full wardrobe for each child when you can mix and match?

But even though your kids might not mind swapping outfits, sharing a 529 college-savings plan is an entirely different matter. For one thing, 529 plans typically require that the account owner name a single beneficiary. This could be a son or daughter, a grandchild, a niece or nephew, a friend's child, or even oneself, but only one beneficiary may be named to the account at a time. (You may, however, change the beneficiary, a topic we'll get to a little later). And while each 529 account can have just one beneficiary, a beneficiary can have multiple 529 accounts. For instance, you can open a 529 account for your child using your state's plan and your child's grandparents can open one for him or her using their state's plan, even if it's the same state as the parents' state.

Keeping Savings Separate
Some parents might think that keeping all of their children's college savings in a single account simplifies their financial record-keeping. But remember that 529 funds must be used for qualified college-related expenses for the named beneficiary only, so you can't just take money from one child's 529 and use it to cover college costs for another (unless you take a penalty). You should also be aware that distributions from 529 plans are reported to the Internal Revenue Service using Form 1099-Q.You'd hate to have to explain to the IRS why you took 529 distributions for thousands of dollars in excess of the named beneficiary's qualified college expenses for a given year. Nonqualified withdrawals are subject to federal income taxes on earnings plus a 10% penalty.

A safer option would be to open separate 529 accounts for each child, divvying up assets accordingly. That way you won't run the risk of incurring a tax penalty, plus it's a nice way to provide each child an account that clearly spells out how much has been saved in his or her name.

If you are concerned that dividing the money up into smaller amounts may pose a problem if one child ends up needing more than the others, have no fear. You can transfer funds between 529 accounts without penalty as long as the beneficiaries are from the same family. (For more on this, read What Can You Do if Your 529 Expectations Change?) So if one child ends up attending a pricey private school and another goes to a less expensive public college, you do have the option of transferring 529 assets from one account to the other.

The Allocation Issue
Another danger of using a single 529 account to cover college savings for more than one child involves families with children of different ages and the allocation problems that can arise. When a child is very young--say, in kindergarten or earlier--college remains more than a decade away, and funds set aside to pay for it have plenty of time to grow and ride out swings in the market, making an equity-heavy portfolio perfectly appropriate. But as that child gets older, and closer to college, that portfolio should tilt more and more to safer asset classes such as fixed income and cash. By the time the child is a year or two away from attending college, the bulk of college savings needs to be in these safer asset classes to guard against any potential drop in the stock market. You wouldn't want to build up a nice college-savings cushion only to see it wiped out just before your child enters college--and just before those hefty tuition, room, and board bills begin arriving in your mailbox.

Many 529 plans offer age-based portfolio options that shift allocations away from equities as the child gets older, and these illustrate why holding all your children's assets in a single account could be a mistake. Take for example a family with three children, ages 7, 12, and 17. The average age-based 529 portfolio keeps 67% of assets in equities when the beneficiary is age 7, 44% at age 12, and just 20% at age 17. Using a single 529 account to cover all three children inevitably means using an asset allocation that might be appropriate for one but inappropriate for the other two. A conservative allocation of 20% may protect assets for the oldest child, but it also deprives the younger children of the potential for larger gains they would have obtained by keeping more of their college savings in the market. Conversely, keeping the family's 529 account at a 67% equity allocation risks losing money needed by the oldest child in the next few years.

A family with twins, triplets, or other multiples might not have this problem assuming that all the children enter college around the same time and therefore have the same time horizon and capacity for risk. But for families whose children will be entering school several years apart, differences in these areas represent another reason to open a 529 account for each child, with an age-appropriate allocation in each case.

No Financial Aid Impact
Finally, a word about financial aid. You may be thinking that by holding all your family's college-savings assets in one child's 529 account the others will stand a better chance of qualifying for financial aid, but that's not the case. The financial aid formula views 529 assets as belonging to the parents (as long as the child is a dependent) and treats them collectively whether they are held in one account or three. So there's really no benefit to this strategy from a financial aid standpoint.

There is, however, a substantial financial aid advantage to having multiple children enrolled in college at the same time. In such cases the formula discounts the amount families are expected to pay to cover college costs for each child, thus increasing financial aid eligibility. Footing the bill for three college educations at once is a tall order, to be sure, but at least there is an upside. 

Have a personal finance question you'd like answered? Send it to TheShortAnswer@morningstar.com.