You want the best for your children or grandchildren. Helping them to cover the cost of a college degree is often a priority. A college degree can be a great start in life to help them to be successful and self-sufficient.
There are a variety of ways to save for college. You can set up personal savings accounts in your own name. Or you could set up uniform transfer to minors act (UTMA), formerly the uniform gifts to minors act (UGMA) accounts that the beneficiary gets full control of at age 18 or 21.
You can use variable universal life insurance policies to have college savings along with life insurance coverage. With Coverdell education savings accounts (ESAs), you can save not only for college, but also for K-12 education costs. The most popular method of savings for college by our firm’s clients are 529 Plans, also called Qualified Tuition Programs (QTPs).
The plans are called 529 Plans because they are provided for in Section 529 of the Internal Revenue Code. They were created to encourage families to save for college. 529 Plans are state-sponsored plans that provide for tax-free withdrawals of amounts used for Qualified Higher Education Expenses (QHEEs). QHEEs include tuition, fees, books, supplies, required equipment, and for students enrolled at least half-time, reasonable room and board at an accredited post-secondary educational institution.
The plans must be established and maintained by a state, a state agency or an eligible educational institution. Earnings on these 529 Plans are not currently taxed and if the distributions are used QHEEs, they are free from federal income tax and maybe free from state income tax. Contributions to a 529 Plan are considered completed gifts, and unless you are using the multiplier effect, they are no longer considered part of your taxable estate. Most 529 Plans have a maximum amount that you can contribute.
There is a special rule for 529 Plans that gives a multiplier effect to the annual gift tax exclusion. You can gift up to five times the $14,000 annual exclusion amount in a given year, or $70,000 per child or grandchild to a 529 Plan, without triggering a taxable gift. A married couple could gift up to $140,000 for each beneficiary. If you take advantage of the multiplier effect, you cannot make any more annual exclusion gifts to that child or grandchild for the next four years. If you die during the next four years, part of the gift is brought back into your taxable estate.
If the named beneficiary of the 529 Plan does not go to college or does not use up the plan funds, the account may be able to be transferred to certain other relatives. You can also distribute the plan funds back to yourself by paying the income tax and a 10% penalty tax on the earnings distributed. This is the only provision in the Internal Revenue Code of which I am aware, that allows you to take back a completed gift.
The state of Michigan has two major 529 Plans, the Michigan Education Savings Plan (MESP) and the Michigan Education Trust (MET). With both the MESP and MET, contributions to the plans can be deducted from your state income tax returns. The MESP is a typical 529 Plan with an account balance from which you make withdrawals to pay QHEEs. The MET, on the other hand, is a tuition-only plan in which you pre-purchase a certain number of semesters’ tuition at a qualifying Michigan college or university.
If you start early when the kids or grandkids are young, there is much less of a financial strain on the family when college time comes. It does not matter what type of college savings you do, just do something.
By Matthew M. Wallace, CPA, JD
Published edited August 29, 2016 in Savvy magazine, Port Huron, Michigan as: Saving for college with 529 plans