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Personal Finance

Your 529 Questions Answered

We answer reader inquiries about what happens when high schoolers take college courses, whether a transfer of ownership constitutes a gift, and more.

Saving for college through a 529 college-savings plan is usually a fairly straightforward process. You find the plan that best suits your needs (perhaps it's your home state's plan if it's decent and offers you an income tax break on contributions), send the money in and choose the investment options you want, then wait until the beneficiary needs the money to pay for college expenses. But sometimes, complications crop up along the way, leaving 529 owners unsure about plan rules and how to get the most out of their accounts.

From time to time, readers send in 529-related questions, which can range from the commonplace to the esoteric. This week, we answer some of these reader-submitted questions.

My son is a senior in high school this year and is in a dual-enrollment program with a local college. Can he access his 529 funds for college expenses if he hasn't quite graduated from high school yet? The IRS rules regarding how 529 assets can be used are rather explicit with regard to what constitutes a qualified college expense (tuition, fees, room and board, and so on). However, they do not stipulate the age or academic standing of the beneficiary when using those assets. Therefore, you can use 529 assets to pay for tuition and costs related to your son taking college courses even though technically he is still in high school. The IRS considers any college, vocational school, or other postsecondary institution eligible to participate in the federal student aid program to be a qualified educational institution when it comes to using 529 funds. You can see if a specific school qualifies by finding its Federal School Code here.

Does transferring ownership in a 529 account to the parent (I am the grandparent) constitute a gift under tax laws? Grandparents (or aunts, uncles, family friends, and so on) who open a 529 account to help pay college costs for someone who is not their own child obviously have good intentions but need to be aware of potential complications that may come along for the ride. For example, there can be a negative financial aid impact for the student when paying for college expenses using funds from a 529 account that is not owned by the student's parents. Also, if the account owner takes state income tax deductions for contributions he or she has made to a 529 plan and later decides to roll those assets into a different state's plan (perhaps one owned by the beneficiary's parents), the account owner could be on the hook to repay any related tax breaks he or she has received. For more on these issues and possible ways around them, read "529 Gift a Great Idea, but First Do Your Homework."

Now, on to your question: According to the College Savings Plans Network, a transfer of ownership of a 529 account does not constitute a gift for tax purposes as long as the account beneficiary stays the same. (Each 529 account has a named beneficiary who will use the money to pay for college expenses and an account owner who controls the funds.) As you may know, under current tax laws, individuals may gift up to $14,000 per year to another individual (or $28,000 as a couple to an individual) before gift tax implications start to crop up. (You can read more about the relationship between gift and estate taxes here.) However, since money in the 529 account remains for the benefit of the same person--a grandchild in your case--and the new account owner (the parent) isn't benefiting directly from the move, this is not considered a gift. In essence, you are just changing who controls money that you've already gifted to your grandchild in the form of contributions to a 529 account in his or her name.

One advantage of consolidating 529 assets into a parent-owned account (if that is your intent) is that it will make it easier to manage the money, as well as to coordinate payment for qualified college expenses. But, as I said, this needs to be done with care, especially if you've taken any state income tax deductions on your past contributions.

I would like to open a 529 for my grandkids, who are 1 and 4. Should I have two separate 529 accounts or can I do it all in one account? Opening up just one account that covers both grandchildren may seem like the easier thing to do for now; but in the long run, each is going to need his or her own account, so you may as well get them started this way right out of the gate.

There are two primary reasons why separate accounts make the most sense. First, 529 rules require that assets in an account be used for the benefit of the named beneficiary only. In fact, you will only be able to open the account in the name of one of your grandchildren. If you tried to use assets from the 529 to pay an unnamed beneficiary's college expenses, you would be breaking this rule and could face tax penalties.

The second reason to open separate accounts is that, as your grandchildren approach college age, the investment allocation needs of each account may differ. Let's say the older grandchild is one year away from college and you want the bulk of the money invested in low-risk holdings such as cash and bonds, while the younger grandchild still has a few years to go and might benefit from having a larger portion of his or her share of the money invested in stocks, which have a higher return potential but also add more risk. Having separate accounts allows you to tailor the allocations to the time frame of each grandchild. Plus, if you choose your 529 plan's age-based portfolio option for each child, the account will automatically adjust to an allocation designed for each child's expected enrollment date. (For more on this, read "When It Comes to 529 Plans, No Need to Share.")

Technically, you could open one account for now, naming one of your grandchildren as the beneficiary, and then plan to open a second account for the other grandchild at some point, dividing the assets between the two. After all, 529 assets can be rolled from one family member's account to another's without penalty. But setting up separate accounts now will save you the hassle of deciding who gets what later, and it will save the successor owner on the accounts (perhaps it's your grandkids' parents) from having to figure out what to do if something were to happen to you.

How big of an impact on need-based financial aid do Coverdell Education Savings Account assets owned by the beneficiary's parents have compared with a 529? We have both and are wondering if we should use the Coverdell money for high school expenses if it will hurt us for college financial aid. It isn't so much a question of where the money is held as it is of who owns the account. From a financial-aid standpoint, assets held in a Coverdell account or in a 529 account are treated the same way. What matters more is whether the account is owned by the parents or the student, since parent-owned assets have a much lower impact on need-based financial aid than student-owned assets do. As an example, let's say you have $10,000 in a 529 or Coverdell account (or divided between the two) and that the account or accounts are owned by the parents. The financial-aid formula says that the parents are expected to use up to $564 (5.64%) of that $10,000 to cover college costs. But if, for example, that money were held in a savings account owned by the student, the formula assumes that $2,000 (20%) of that $10,000 is available to help pay for college. So, not only do Coverdell and 529 accounts convey tax advantages when used to help pay for qualified college expenses, but they also offer a lower negative impact on financial aid as compared with holding the money in a student-owned account.

As you suggest, a key difference in the two account types is that the Coverdell ESA can be used to cover pre-college costs as well as college costs, whereas assets in a 529 account may only be used to pay for college costs. So, from that standpoint, it may make sense to spend down the Coverdell ESA if you need the money to pay for educational expenses while your student is still in high school. But if you end up holding on to the money to help pay for college, you'll be no worse off from a financial-aid standpoint than if you'd held it in a 529.

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