If you want to save money for a loved one to use to pay for college, you should consider a 529 college savings plan. From an estate planning perspective, this type of plan can be ideal if you want to set aside resources for a grandchild or great-grandchild.
There are considerable tax benefits if you take maximum advantage of a 529 plan. Before distributions are made, the earnings are not subject to income taxes. The distributions are tax-free as well as long as the money is used to cover qualified educational expenses.
You can apply your understanding of Roth individual retirement accounts to 529 plans. Assets in the plan are invested in the same manner that the resources in an IRA would be invested. The contributions are made after taxes have been paid on the income, so the distributions are not subject to further taxation.
Any adult can open a 529 plan as long as they have a Social Security number or Tax ID number. In fact, you can be the beneficiary of a 529 account that you establish for yourself.
Obviously, if you establish a 529 plan, you can make contributions as you see fit. Plus, other family members and friends can contribute into the account as well. These plans do not have contribution limits on an annual basis, but there is a $300,000 aggregate limit in Connecticut.
With regard to the annual distributions, high net worth individuals should be aware of the potential impact of transfer taxes. There is a federal gift tax that is unified with the estate tax, and the unified exclusion is $12.06 million in 2022.
In addition to this exclusion, there is also a $16,000 per person, per year annual exclusion. If you do not want to use any of your large multimillion dollar exclusion to fund a 529 plan tax-free, you should limit the contributions to $16,000 per year.
Traditionally, the money in the plan could only be used to pay for postsecondary educational expenses. Recently, the parameters were expanded, and up to $10,000 per year can be used to cover K-12 educational expenses.
In addition to tuition, the resources in a 529 plan can be used to address living expenses, books, fees, etc. It should also be noted that the person that establishes the account can withdraw money at any time, for any reason, but there is a 10 percent penalty. They would also be required to pay income taxes on the earnings.
When an account is opened by the student or a parent, there is virtually no impact on student aid. However, when a grandparent or someone else establishes a 529 plan, it is looked upon as cash support for aid purposes.
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