Breaking the Small Business Code

Unsettling Grandparent Question on 529 Plans

   Anyone who follows my blogs and my career as a college funding advisor knows that I am not a fan of 529 Plans as a way to save for college. In my opinion, tax-free growth of your funds is not a good enough reason to use 529s when you discover all the "gotcha's" and gray areas surrounding them!

      One of the big gotcha's used to be 529 plans would impact the Financial Aid of the beneficiary. This was changed  by the 2007 College Cost Reduction Act (CCRA). The Act specifically states that qualified distributions to a student from student- and parent-owned 529s would not be included as student income on the FAFSA and would not reduce financial aid from a college to the student.  However, there is a "gray" area involving grandparent-owned 529s that was brought to my attention today.

     Financial and tax professionals often recommend 529 plans to grandparents like me as a way to move taxable assets out of an estate but still be able to maintain control over the gifted money should the beneficiary grandchildren not go to college. There are generous gifting limits and the growth would be untaxed as long as the distributions were used for qualified college expenses outlined by the IRS.  But the distributions from a grandparent-owned 529 account were NOT specifically mentioned or exempted for financial aid in the CCRA! 

      Some financial aid experts now worry that distributions from a grandparent-owned 529 are student income.  That means they must be included in the FAFSA according to the rules that clearly state  ". . . money received, or paid on your behalf (e.g. bills), not reported elsewhere on this form must be reported."  Financial aid expert Mark Kantrowitz argues that distributions are exempt regardless of ownership based on the intent of all the regulations even if it grandparents are not specifically named.  But Joe Hurley, the CPA who is considered "THE" expert on 529s, feels the situation is ambiguous. 

       So what do you do?

  There may ways to avoid financial aid impacts by changing ownership to the student or parent. HOWEVER, you MUST work with a VERY experienced college financial and/or tax planner famiiar with 529 rules. The process for gifting and changing owners between generations for 529s can be very confusing and complex.

      Grandparent-owned 529s are now firmly in the gray area and that makes me uncomfortable recommending them.  Students applying for federal financial aid face potential legal and tax consequences if they receive disributions from a grandparent-owned 529!  If a student does not include distributions on the FAFSA and it is later found they should have been counted, there could be taxes and the requirement that aid be refunded!  If a student does include the distribution and it is later found to be exempt,  they will have potentially lost financial aid including grants and scholarships for no reason!

      If you are a grandparent with a 529 Plans, meet with the advisor who sold them to you and get a written opinion on their impact on financial aid including IRS and Department of Education citations. If you do not yet have a 529 plan, discuss other tax-advantaged ways to save for college such as trusts and insurance products like cash value life insurance and annuities.

529 Plans and the Market!

The market hit extends deep into the pockets of college-bound and college families!  The market melt-down has impacted many 529 Plans!

If your 529 plan uses mutual funds, you probably took a hit.  Mutual funds are "buying clubs" that invest in stocks, bonds and real estate products.  So where these financial vehicles go (up or down) is where your mutual funds go.  And where your mutual funds go (up or down), there goes your college money.  And depending on your combination of mutual fund subaccounts - that hit could be anywhere from 1 to over 10% in losses.  Here is a printout from today for Vanguard which  I randomly selected to show you what may have happened to your 529 Plans.  Click on the page to link to the original.

Depending on who runs your 529 and what mutual funds they use, you may find yourself with much less than you had last Friday! 

I would recommend you call the financial professional who sold you the 529 Plan to see what makes up your investment and where you stand.  Discuss your options with someone knowledgeable.  BUT PLEASE DO NOT do anything rash!  There are potential tax consequences to changing or liquidating accounts.

HOWEVER, if you no longer have any gains inside your account, this may be an opportunity to move your funds to a non-529 location.  If you wanted to access your 529 for non-college reasons but were hesitating because of the tax hit, this may be a good time.  Again, discuss this with your financial advisor! 

I would also recommend you talk with an experienced COLLEGE financial professional to review all your options for college savings.  There are vehicles that are not as susceptible as mutual funds to market forces.

If you own or sell 529 Plans, let me know what you think . . .

Is a 529 Plan included in the FAFSA?

ORIGINAL DATE: 01/21/2008 03:58:03 PM

I just got a call from a client family confused about how to account for their daughter's 529 Plan on the FAFSA.  So to help all those families in the similar situation, here are some suggestions:

• Ownership of a 529 is the key.  The beneficiary is irrelevant for the FAFSA.
• If a parent owns the account, it IS included in the parent's asset total.
• If grandparent's own the account, it is not included in the FAFSA.
• If the student owns the account, the asset is not included on the FAFSA.  NOTE - if the student is under 18 (age 21 in some states and circumstances), the account is usually held in a UGMA/UTMA status.  That means it is owned by the "child" but a custodian has authority to make decisions on the account.  So a UGMA/UTMA 529 Plan is NOT included on the FAFSA.
• 529 Plans for other non-college aged students are included in the parent's assets.

These guidelines ONLY apply to the federal FAFSA.  So if your student is applying to colleges requiring the CSS Financial Aid Profile, you will need to answer their questions about 529 plans REGARDLESS of ownership.

College Loans More Expensive Because of New Bill

ORIGINAL DATE: 10/17/2007 07:31:34 PM

Despite what the Congress and the media are saying, the recently signed College Cost Reduction and Access Act of 2007 has made college borrowing MORE expensive despite cutting the interest rates on Federal Family Education Loans (FFEL).

To pay for the increase in Pell Grants, the Bill cut subsidies to the student loan industry by almost $21 billion. This new legislation cuts directly into the lender’s loan margins.  As expected, banks and other lenders who offer the FFEL Stafford loans, parent PLUS loans, and federal consolidation loans began to cut back on their ‘borrower discounts’ as soon as the bill was signed.

The lenders had used the various discounts, rebates and waivers to compete for borrowers because the actual loan interest rates are fixed by Congress.  These discounts could save families as much as 2.5% on FFEL loans. But now lenders like Wells Fargo and Nelnet are eliminating these key borrower benefits like discounts for auto debit from checking accounts and repayment rebates on new federal loans. Nelnet also reinstated its loan origination and default fees on its student Stafford loans.   Some lenders, such as Bank of America, Chase, and KeyBank are currently evaluating their programs.

I know it is tempting to blame the "evil" banks for eliminating their discounts.  But the lenders have what is called "a fiduciary responsibility" to make a profit on loans for their stockholders.  And if you own a mutual fund or a 529 Plan, you are probably a stockholder without realizing it!  I understand why lenders are doing what they are to keep their margins alive.  But that is little consolation to families who will need the loans for the coming college years.

If your plan to pay for college includes education loans, we urge you to learn more about the strategies available that not only can help you reduce your amount of borrowing, but reduce your taxes too.  In many cases there are techniques that can help you increase your cash flow to cover college expenses, including more expensive loans, without changing your current lifestyle.

Congress Hits College Families (Again)

ORIGINAL DATE: 08/19/2007 07:57:06 PM

It never fails, what the Congress says is apparently rarely reflected in what they do. And to be fair, it has happened both in a Republican and Democrat Congress so no politics are involved in this blog!

 

They say they are pro-college and then turn around and create a law that hinders your ability to pay for it!

 

The age at which a child is taxed at their parent's tax rate used to be 14. This was called the "Kiddie Tax". The theory was it kept rich people from gifting things to their children who would be in a lower or zero tax bracket.

 

Last year, they increased the age at which you are a "child" RETROACTIVELY to 18. At least this let families with college children save tax dollars and use them for college.

 

Well along comes the U.S. Troop and Readiness, Veteran's Care, Katrina Recovery, and Iraq Accountability Appropriations Act of 2007. Buried in the Act was Section 8241 which was the Small Business and Work Opportunity Act of 2007 (confused yet?). This totally unpublicized section changed last year's age of 18 to the age of 25 IF the child is in college at least 1/2-time! And again, it was retroactive. So a family cannot take advantage of a student's lower tax bracket until the student graduates or turns 25.

 

There is a LOOPHOLE for just for this tax year. Any college student who turned 18 in 2007 is EXEMPT from the tax! But, they are nailed with it next year when they turn 19. So if you and your financial team were planning to use what I call "Tax Capacity" to help pay for college, you've got a narrow window to act!

 

As always, feel free to respond to this blog if you have questions or need more information.

529 Plans - Good Thing or a Tax Trap?

ORIGINAL DATE: 08/01/2007 10:21:04 AM -----
It's no secret I am not a big fan of 529 Plans.  They were created with good intentions but are often misunderstood, improperly sold, and improperly applied by the families they were supposed to help.  529s are like a chainsaw -  they are a great timesaver but you MUST understand how to use them properly or someone will get hurt! The main problem with 529 Plans is they are written in "financial-speak" and most advisors are not allowed to translate it into simple English for compliance reasons.  Here is an example:  "Growth from a 529 is income to the Plan BENEFICIARY also known as the DISTRIBUTEE.  Income/growth is tax-free IF AND ONLY IF (1) the withdrawal matches the QHEE as DEFINED BY THE IRS and VALIDATED by the college for the student beneficiary and (2) the total withdrawal is equal to or less than the TOTAL Adjusted QHEE the beneficiary student incurred.   You also must withdraw the money in the SAME year it is spent as QHEE.  It can be a reimbursement or withdrawn to be spent."  Got that? The QHEE is VERY limited and not just what the owner thinks is needed for college.  IRS Publication 970 has the list.  For example, a laptop is not necessarily a QHEE.  Sadly, colleges can really muck-up the list based on how they apply things like student loans and scholarships.  If the student receives a scholarship and the college applies that scholarship to QHEE tuition and fees, the QHEE is adjusted or reduced by the scholarship.  But if the school applies the scholarship to non-QHEE needs, the QHEE stays intact.  One of the biggest surprises with 529s is when a family takes the Hope Credit or Lifetime Learning credit. Even CPAs are shocked to learn usually AFTER THE FACT, that taking the maximum tax credit reduced the previous year's QHEE by $10,000!!  Families in this situation then have to decide which creates less tax: claiming the perfectly legal credit OR paying taxes and penalties on the excess 529 withdrawal!

Confused yet?  I know most college families I see are! 

So if you plan to use a 529 Plan, take the time to learn the details --  ALL THE DETAILS -- so you are using it properly in YOUR UNIQUE situation. Please feel free to contact me through this blog or my contact me page!