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April 24, 2008
HELPING WITH COLLEGE EXPENSES
For those of you with children or grandchildren who will be attending college soon, I have to tell you that college tuitions have skyrocketed! My son is a senior in high school this year and will be attending college in the fall. He has been accepted to five different colleges where the tuition, room and board expenses are all over $40,000. If you grandchild is going to Boston College next year, the tuition will be $47,139 not counting books and other personal expenses.
One option for parents or grandparents who want to assist in financing a college education is something called the 529 plan. It is named after Internal Revenue Code Section 529.
I spoke with Andy Tapparo, from Tapparo Capital Management in Topsfield about Section 529 plans and other options that parents and grandparents have to save for college. According to Andy (and other research that I did), here are the pros and cons of 529 plans:
THE PRO’S:
· ESTATE PLANNING TOOL – Gifts that grandparents make to a 529 plan are considered a completed gift, getting the asset out of your estate and on to your grandchildren free of estate taxes. Grandparents can make a one-time non-taxable gift of up to $60,000 for their grandchild’s education as long as the grandparent makes an election on a gift tax return. A gift tax return should be filed for any gift to a 529 plan over $12,000, the annual exclusion amount.
· YOU STAY IN CONTROL – The money doesn’t go to the college or the grandchild until you say so. In the event that your financial circumstances change, you have the right to get your money back whenever you want. If you request a refund, the amount that you had originally contributed returns to you tax free. The earnings on the money is taxable as ordinary income, plus a 10% penalty for not using it for educational expenses. In the event that your grandchild goes to college, Andy Tapparo recommends that you have the 529 plan make the distribution directly to the college to eliminate having to report the 529 plan earnings on your tax return.
· FLEXABILITY – What happens if your grandchild decides not to go to college? You can change the beneficiary whenever you want. So if your grandson doesn’t go to college, you could then name your granddaughter as the new beneficiary. You can change the beneficiary as many times as you wish.
THE CON’S:
· MEDICAID CONCERNS – For gift tax purposes, gifts to a 529 plan are considered completed gifts. But for Medicaid purposes, it is an incomplete gift because the asset could be returned to the grandparent. So, if grandparents create a 529 plan for their grandchild, and end up needing nursing home care, the assets in the 529 plan might end up being returned to the grandparent and paid to the nursing home as part of their spend down. Not a good result.
· ADMINISTRATIVE EXPENSES – Almost every state has a 529 plan. Some have administrative expenses higher than others and returns vary by which plan you invest in. It could very well be that if you only have a few years before the child will need the money, the administrative fees charged would make the choice of a 529 plan unattractive. If the child will not be going to college for 15 years, the administrative fees are no longer a concern.
529 Plans and Financial Aid – The rules are changing on how 529 plans affect financial aid. If the parent owns the 529 plan, it is reported as an asset on the Federal Financial Aid Application (FAFSA) and assessed at 5.64% in computing the expected family contribution. A 529 plan owned by the student is non-reportable. Beginning with the 2009-2010 school year, student owned 529 plans will be reportable as a parental asset and assessed at the 5.64%. Section 529 plans owned by grandparents are not reportable on the FAFSA for either the parent or the child. This could produce more financial aid unless your grandchild goes to a school that not only requires the FAFSA, but also the College Profile. The Profile is another questionnaire that is required by many schools (all the schools that my son applied to required it) and asks questions beyond that of the FAFSA. One of the things they ask is whether the student has access to any 529 plans, including those owned by grandma. So, if grandparents are willing to relinquish control over gifts made to a 529 plan in order to protect the money from Medicaid, they could make gifts to a 529 plan established by one of the parents or guardians.
Andy Tapparo brought up an interesting alternative that might fit some families, using a Roth IRA to fund college expenses. A Roth Individual Retirement Account (Roth IRA) is like the traditional IRA, except that you do not get a tax deduction for contributing to the Roth. Earnings grow tax free and distributions are not considered as income until you withdraw more than what you contributed. Generally, IRA distributions are subject to an early withdrawal 10% penalty, if you are under 59 ˝. This penalty is waived if you use the money for qualified education expense, and you wait 5 years before taking any distributions from the Roth. Retirement accounts are not counted on either the FAFSA or Profile in determining your expected family contribution, so you end up with an asset that is not counted for financial aid and grows tax free. Not too shabby. Here, the grandparent could make a gift to the parent to fund the parent’s Roth IRA for educational purposes. Consult your tax advisor to see if this could work for you.
Grandparents also need to recognize that if they need nursing home care within 5 years; ALL gifts made within the past 5 years are subject to the Medicaid lookback penalties and in certain cases, will have to be returned to the grandparent to pay for their nursing home care.
This article gives general information and not specific advice on individual matters. Persons wanting individualized advice on matters discussed should contact an advisor experienced in those matters. To the extent this article provides information on legal matters, it is based on law in effect in Massachusetts on the date of posting (laws in effect in other states are often quite different).
Ronald H. Surabian is a CPA and attorney who works at the Elder Law Center in Saugus, Massachusetts. He also holds Masters in accounting and a Masters in tax law. He currently serves on the board of directors of the Massachusetts Chapter of the National Academy of Elder Law Attorneys. If you have any questions please call me at the Elder Law Center, One Essex Street, Saugus, MA 01906 (781)233-4444. To view this or any prior article, please visit our web site at www.elderlawcenter.org