IndyBar: Overview of U.S.C. §529 College Savings Plans for Indiana Estate Planners

By Ashley A. Butz and Shawn M. Scott, Hall Scott P.C.

Named after the Internal Revenue Code section that governs them, Section 529 College Savings Plans (529 Plans) are higher-education savings plan trusts established under section 529(b) of the Internal Revenue Code as “qualified tuition programs.” 529 Plans offer tremendous benefits when planning for educational expenses. Unlike irrevocable trusts set up to fund a beneficiary’s education that may be taxed at higher trust income tax rates, assets held in a 529 Plan grow income tax-free and all distributions are also tax-free so as long as they are used for qualified education expenses. CollegeChoice 529 is a 529 Plan offered by the Indiana Education Savings Authority. CollegeChoice 529 offers multiple investment options based upon the account owner’s preferences and risk tolerance and are specifically designed to fit the time parameters between birth and college.

Qualifying education expenses. Qualifying educational expenses that receive tax-free treatment include tuition, fees and the costs of textbooks, supplies and equipment required for the enrollment or attendance of a beneficiary at an eligible educational institution, certain costs of room and board, expenses for special needs, expenses for the purchase of computer or peripheral equipment, computer software, internet access and related services. Qualifying educational expenses also include expenses for tuition in connection with an elementary or secondary public, private or religious school (i.e., K-12 tuition). Because most plans offer age-based investment options that will automatically adjust allocations over time as a child gets closer to college, account owners may consider separate plans for K-12 tuition.

Account owner. To participate in CollegeChoice 529, the account owner must be an individual 18 years or older or an emancipated minor (as determined by Indiana law), a trust, an estate, a partnership, an association, a company, a corporation, or a qualified custodian under the Uniform Gifts to Minors Act/Uniform Transfers to Minors Act (UGMA/UTMA). An account owner must also be a U.S. citizen (or a resident alien) or an entity that is organized in the U.S. and has a valid permanent U.S. street address.

The account owner can change the beneficiary, approve or disapprove distributions to the beneficiary and withdraw funds. A 529 Plan is not owned by the student beneficiary. Note: An UGMA/UTMA custodial account is subject to additional requirements and restrictions. For instance, the custodian of a 529 Plan funded from an UGMA/UTMA account may not change the account owner or beneficiary. The beneficiary of an UGMA/UTMA 529 Plan will become the account owner when the custodianship terminates and the beneficiary is legally entitled to take control ofthe account.

Contribution. Multiple parties can contribute to the same 529 Plan, but total contributions cannot exceed $450,000 for all accounts for the same beneficiary of a CollegeChoice 529 Plan. The account owner chooses the plan’s investment portfolios and distribution of the funds.

Designating a successor account owner. Naming a successor account owner of a 529 Plan is an important part of the estate planning process. The successor owner will manage the 529 Plan for the beneficiary in the event of the account owner’s death. A successor owner has the same rights and decision-making power that the original owner had (i.e. the right to change the beneficiary or take out a nonqualified withdrawal), so it is important to name a successor who is like-minded about the owner’s intended use for the 529 Plan. Keep in mind that a successor account owner becomes the owner of the account for all purposes including the FAFSA financial aid application. Further, if a successor owner is not chosen, the new account owner may have to be decided through the rules established by the plan or by the local probate court.

Revocable trust as a successor account owner: A 529 Plan owner may designate a trust as the successor owner. Consider the following advantages and disadvantages of a 529 Plan owner naming a trust as a successor owner:

Advantages

• A trust may establish a succession of 529 Plan beneficiaries and related distribution instructions to be executed by the trustee.

• Having a trust as the account owner of a 529 Plan ensures the funds will be used for the purposes set forth in the trust and cannot be withdrawn by a successor account owner who was not the intended beneficiary.

Disadvantages

• Making a trust a 529 Plan account owner places additional administrative burden on the trustee to manage the account separately from the other trust assets. The trustee may have increased expenses related to legal and tax assistance.

• There may be special legal and tax considerations when determining how best to use the 529 Plan, particularly in trusts set up so that assets may be “sprinkled” among the trust beneficiaries. A 529 Plan account can only have one beneficiary at a time.

Choosing a beneficiary. A 529 Plan can be established for the account owner’s benefit or the benefit of the account owner’s child, grandchild, spouse, another relative, or even someone not related to the account owner. A beneficiary may be of any age; however, the beneficiary must be an individual. Each account can have only one beneficiary at any time. However, multiple accounts can be established for each beneficiary. Also, different account owners may have an account for the same beneficiary, but contributions to an account will be limited if the total assets held in all accounts for that beneficiary under all 529 Plans offered by Indiana equal or exceed a maximum account balance.

Parents who wish to establish a 529 Plan for an unborn child can designate one of the parents as the plan beneficiary prior to the birth of the child. When the child is born and is assigned a Social Security number the parents can change the beneficiary to the child and select an appropriate age-based investment option.

When education plans change. There are no restrictions on when the CollegeChoice 529 account can be used to pay for educational expenses. If a beneficiary does not incur educational expenses, the account owner has three options:

1. Stay invested. The account owner can leave the money in the account in case the beneficiary decides to attend school later. There is no age limit for using the funds.
2. Change the beneficiary. The account owner can change the beneficiary on the account at any time provided that the new beneficiary is an eligible member of the family of the former beneficiary. The IRS allows one tax-free rollover in a 12-month period. A qualified family member means an individual who is related to the beneficiary as follows: a child or stepchild (including a legally adopted child or a foster child); a sibling, stepsibling, or half- sibling; a parent, or stepparent; a grandparent; a grandchild; a niece or nephew; an aunt or uncle; a first cousin; a mother- or father-in-law, son- or daughter-in-law, brother- or sister- in-law; or a spouse of any individual listed (except first cousin). If there is a large age gap between qualified family members, the account owner should be mindful of age-based investment options on the account that will roll over to the new account/beneficiary. Investment options for a 529 Plan can be changed twice per calendar year, and with a permissible change in the beneficiary.
3. Withdraw the money for other uses. The earnings portion of a withdrawal not used for a beneficiary’s qualified education expenses is subject to federal and state income taxes and may be subject to a penalty tax.

Collegechoicedirect.com is Indiana’s 529 Plan website and offers more detail on these matters.•