COLLEGE PLANNING
How to Gain Tax Breaks
Through Your 529 Plan
By LYNN ASINOF
Staff Reporter of THE WALL STREET JOURNAL
Traditional college-savings vehicles are being stretched, modified and sometimes even dismantled as people try to cash in on the tax advantages now offered by 529 plans.
Known as 529 plans for the tax section that created them in 1996, these state college-tuition savings plans got a huge boost last year when Uncle Sam made the plans tax-free as long as withdrawals are used for college expenses.
"Clearly a 529 plan, if you use it for education, is the best deal around," says Timothy Lane, vice president of tuition financing in New York for TIAA-CREF, a nonprofit pension and financial-services company that now operates plans for 13 states.
That fact hasn't been lost on people who originally stashed their kids' college money in custodial accounts and trusts. Many have simply stopped putting money into these traditional accounts; many others are taking steps to actually get the money out.
Making It Work
Some are using escape clauses to terminate irrevocable trusts established for their kids; others are liquidating their custodial accounts. Still others are keeping their old college-savings structures, but finding ways to make them work within the 529 plan rules.
New York attorney Martin M. Shenkman, for example, is planning to open 529 accounts for his kids -- but using existing trusts to do it. The trusts will become the owners of the accounts, and the result will be lower tax bills. "From an income-tax perspective, it makes sense," he says.
Under all these scenarios, the tax savings can be significant. With custodial accounts, children under the age of 14 fall under the "kiddie tax," which means all investment income over $1,500 is taxed at the parents' rate, rather than the child's typically lower rate.
The tax bite can be even bigger if the college funds are in a trust. Here, the top tax rate of 38.6% kicks in after $9,200 of annual income. And that doesn't include the cost of operating the trust, such as annual tax returns and other legal paperwork.
Dismal stock performance makes it a particularly good time to switch from traditional college funding to a 529 plan. That is because 529 plans accept only cash, forcing people to liquidate any investments before making a move. But with stock prices so low, many people will be able to cash out now without incurring capital-gains taxes.
"Now is a great time to do it" because there may not be any tax impact, says Christopher Cordaro, a financial adviser with RegentAtlantic Capital, a Chatham, N.J., investment-management firm.
Customer demand already has prompted rule changes in several state plans to allow trust ownership of accounts and to accept custodial account money. "Our customers definitely have requested that," says Eric Nottonson, vice president of college planning for Fidelity Investments, Boston. So starting in July, Fidelity will begin offering both options in all three state programs it manages: Massachusetts, New Hampshire and Delaware.
Two programs managed by TIAA-CREF -- Michigan and Oklahoma -- are also in the process of making those changes, while eight others already allow such trust and custodial accounts.
Terms and Restrictions
But any custodial money going into a 529 plan retains its custodial character, says Dane Dudley, a partner with the law firm Day, Berry & Howard in Hartford, Conn. That means you won't be able to name a different beneficiary if that child decides not to go to college, as you otherwise could with a 529. Likewise, 529 accounts owned by trusts will continue to be governed by language in the trust document, he says. As such, trustees need to make sure they are meeting their fiduciary responsibilities in managing the 529 plan accounts.
Not surprisingly, the number of people opening custodial accounts has dropped significantly. T. Rowe Price, for example, saw a 55% drop in new custodial accounts last year, and Fidelity Investments says the number of new custodial accounts has been declining since early last year.
The number of new trusts also is diminishing, says Mr. Shenkman. "I wouldn't be surprised if half the people who were going to set up trusts are now going to set up 529 plans," he says.
But neither trusts nor custodial accounts are likely to disappear. Lots of people still want the kids to have money for things other than college. And the 529-plan structure doesn't work for others who need more flexibility than the limited investment options provided by the state-run plans. Among them, says Mr. Shenkman, "investment professionals who feel they can do better." |
