Ask a CFP® Professional
Rita Cheng, CRPC, CFP®
Financial Advisor,
Ameriprise Financial Services, Inc
Bethesda, MD

Question:

“I would like to begin a savings plan for my two grandsons.  I would like for the plan to allow for savings, but the two boys will only be allowed to withdraw money when they are entering into college.  Is this possible?”

-LW

Answer:

With the rising cost of attending college, educational benefit money simply doesn't go as far as it did a few short years ago. Even with more alumni support and increased government spending, the competition for scholarships and tuition assistance is more intense than ever.

But don’t worry- you still have plenty of options to help your grandsons pay for college! 

Personal accumulation (savings) is often easiest using a systematic savings plan, like a 529 College Savings Plan or a Coverdell Education Savings Account (CESA).  Withdrawals from these accounts can be made only for educational expenses, and both have significant tax benefits.

529 College Savings Plans
529 Plans are education savings plans designed to help families dedicate funds for future college costs.  They are named after Section 529 of the Internal Revenue Code.  These plans allow consumers, regardless of age or income, to contribute after-tax dollars to education accounts established for themselves, their children, their grandchildren, or others. So, these dollars can only be used for college education. 

Generally speaking, 529 plans are established in one particular state, but these plans can be used to pay for qualified educational expenses at colleges and universities throughout the nation.  In other words, your grandchild's choice of school will not be negatively impacted by the state in which you establish the 529 plan. For example, you can be a DC resident, and you can establish a DC 529 College Savings Plan for your grandchild who lives in VA and plans to attend college in NC. 

In a 529 prepaid tuition plan, participants can prepay the cost of an in-state public education by locking in tuition at today's prices. If you are concerned about stock market volatility and have a shorter time horizon, you would probably select the prepaid tuition option. 

In 529 savings plans, participants invest their contributions in mutual funds. Some plans permit contributions of as little as $25 per month if you set up automatic monthly deductions from your checking account. 

529 savings plans offer various investment options, such as portfolios based on age of enrollment or your investment risk profile.  In the 529 savings plan option, your account will fluctuate based on the performance of your specific investment options.

Fortunately, you will pay no federal income taxes on withdrawals from 529 plans used for qualified education expenses.  Many states also offer state income tax advantages for 529 plans. For instance, as of May 17, 2008, contributions to the District of Columbia 529 plan of up to $4,000 per contributor per year are deductible for purposes of determining District of Columbia taxable income.

Additionally, Grandparent-owned 529 accounts are not counted in determining eligibility for financial aid. For this reason, your use of 529 plans is better from a financial aid standpoint than gifting to a Uniform Gifts to Minors Act (UGMA) or Uniform Transfers to Minors Act (UTMA) account where the value of the UGMA/UTMA, and any earnings or gains reported on the student's income tax return, are counted heavily in the financial aid determination.

In selecting a college savings plan, you may want to consider your own state's plan and any state income tax benefits available on contributions.

For more information regarding the DC 529 plan, please visit www.dccollegesavings.com  or call (800) 987-4859 for DC residents or (800) 368-2745 for non residents.  

For the MD plan, please visit www.collegesavingsmd.org  or call (888) 463-4723.

For the VA plan, there are several options; please call (888) 567-0540 or visit www.virginia529.com.  Alternatively, you may call (800) 421-0180 x529 or visit www.americanfunds.com/college/college-america/index.htm.

Coverdell Education Savings Accounts (CESAs)
Another college savings option is the Coverdell Education Savings Account, or CESA, available at many credit unions.  Like 529 plans,
Coverdell ESAs represent a tax-deferred and potentially tax-free way to save for college expenses.  Unlike 529 plans, Coverdell ESAs offer one distinct benefit: tax-free withdrawals for qualifying educational expenses for K-12 costs in addition to college expenses.

However, for grandparents in particular, CESAs present challenges that don’t occur with 529 plans.  One potential issue is that the maximum annual contribution to a CESA is $2,000 for any child, and contributions from all sources are applied towards this limit. If you were to put $2,000 into your grandchild's CESA in the same year that his parents, other grandparents, or anyone else contributes to his CESA, the annual limit would be exceeded and your grandchild may be assessed a penalty.  In some cases, it may be difficult to determine everyone who is contributing to the CESA.

Another concern with CESAs is that grandparents do not retain the same degree of control over contributed funds as 529 plans allow.  Most CESA custodial arrangements stipulate that the child's parent or guardian be the "responsible individual" on the account, thereby excluding the grandparent.   Even if you were to find a CESA provider (bank, mutual fund, brokerage, etc.) that allows grandparents to be listed as the "responsible individual", you will not be able to request a refund like you can with a 529 plan.  CESA are held in trust under a custodial arrangement for the beneficiary (your grandson), and distributions are reported under the beneficiary's social security number.

Finally, good luck to you. Remember, every dollar you save/invest today is one less dollar your grandsons will need to borrow in the future. Also, remember that you do not have to do this all alone.  Take advantage of available resources like www.savingforcollege.com, or http://www.dccollegesavings.com/.

And, as always, if you have access to professional advice, be sure to discuss your particular situation with your professional tax advisor, financial advisor or legal counsel prior to making any investment decisions.