From the November 2006 issue of Wealth Manager Web • Subscribe!

Nurturing 529s

Now that it's clear that 529 plans will keep their tax-advantaged status, long-term planning with these versatile vehicles is more important than ever. Tom McCarthy, CFP, president of McCarthy Financial Advisors in Marysville, Ohio, notes that prior to the end of July, the tax savings in these plans were "in doubt and subject to expire in 2010. This [new legislation] should give people more confidence and avoids an unhappy surprise." Estate-planning tactics involving 529 plans can now come to full fruition. Planners and clients who were dubious about the future of 529 plans can now take a fresh look at them. While they are first and foremost a college-savings strategy, they have other uses and provisions as well.

No one likes to consider bankruptcy, but it happens. Still, it doesn't have to gut a 529 plan.

Title II (Enhanced Consumer Protection) in Section 225 of the 2005 Bankruptcy Abuse Protection Act, addressing protection of education savings, lays out the exclusions for 529 funds in the event of a bankruptcy filing, says Michael Denny, a CFP and CPA at Grantham Poole PLLC in Jackson, Miss. "It's hard to interpret the legalese," and advisors will want to check with their own attorneys, he says, "but my understanding, and what I have heard from experts, is this money is fully asset protected once the funds have been in the 529 two years."

Regina Watson, associate general counsel and a vice president responsible for the 529 businesses at T. Rowe Price Associates in Baltimore, agrees that 529 investments would most likely find creditor protection under the 2005 federal bankruptcy statute, albeit with a few stipulations such as requiring that beneficiaries of the plan are one's children, stepchildren or grandchildren. Watson notes that since 529 plans and their rules vary widely from state to state, ground rules in terms of bankruptcy protection will also differ somewhat. Advisors will want to look to their own state plan where desired protection is not afforded by federal law, she says.

Two states offering very strong protection are Maryland and Alaska. A section of The Maryland College Investment Plan provides, for instance, that "Under Maryland law, your account is not subject to attachment, garnishment, or seizure by creditors of you or the beneficiary."

The plan statement also notes that "Federal law also provides limited creditor protections based on the timing of contributions and the creditor's relationship to the beneficiary." Contributions made to a debtor's account less than one year before the filing of a bankruptcy petition generally would not find protection, however.

Under Alaska law, accounts are protected from the claims of creditors except in certain instances involving child support obligations, Watson points out.

Other Provisions

Advisors have been taking advantage of other aspects of 529 plans--sometimes gingerly, until now. Here are some other wealth planning features planners and their clients tend to like most:

o The ability to remove assets from the investor's estate, yet still retain control over them. "The 529 is a completed gift with a string on it," observes Michael Mattise, CFP with Radnor Financial Advisors in Philadelphia.

o The ability to aggregate five years' worth of gifts per child or relative without running afoul of gift taxes. "For married grandparents, that means [each] grandparent could gift $60,000 to one grandchild in one year," observes Peter D'Angio, CFP with College Invest, a not-for-profit division of the Colorado Department of Higher Education in Denver.

o Making the most of tax planning. For instance, Pennsylvania residents have the newfound ability to invest in another state's college savings plan without adverse local tax consequences. "Pennsylvania just came out with a new law," says Mattise, whereby "You don't have to be in Pennsylvania's plan to avoid Pennsylvania taxes on qualified distributions or to be eligible for Pennsylvania's deduction on contributions up to $12,000 per beneficiary."

This last item received considerable attention after a court ruled in Kentucky that a state tax on the interest on out-of-state municipal bonds was unconstitutional. The issue may head to the U.S. Supreme Court. Experts quickly wondered if this would carry over into 529 plans. Would each state have to give the same tax advantages to other states' plans?

Not so fast, advises Joe Hurley, the 529 pundit from "That ruling applied only to municipal bonds. Applying it to 529 plans is a leap." His advice is to not bank that tax parity will become law. Some states have done this, and it may be a trend, he continues, "but I'm not advising anyone that the lack of parity in 529 plans will be declared unconstitutional."

Long Arm of the Government

Meanwhile, there are other tax issues to concern yourself with: Yes, it is true that amounts invested in 529 plans are generally not counted in a decedent's estate. Nonetheless, "The government will claw back some gifts and count them," observes CFP Tom McCarthy.

"For example, if Grandpa gifts $60,000 into a 529 account for the benefit of his grandson and dies one month later, $12,000 would not be in his estate because he was entitled to make a $12,000 gift this year. However, the $48,000 for years two through five is counted as his asset because he has not 'earned' that gift exclusion by living those years."

On the upside, the 529 gives wealthy grandparents the ability do some "generation skipping"--something which may be of particular interest to those who may have already used up their lifetime generation-skipping tax exclusion. Generation-skipping taxes are designed to "keep wealthy people from giving away all of their assets before they die, and avoiding estate or gift taxes at the level of the following generation," says CFP Ray Benton, who heads up Benton & Company in Denver. "Anything that qualifies for the $12,000 [per year gift tax] exclusion," cited above, "is excluded from generation skipping taxes as well," he explains.

Roughly 40 percent of Benton's 200-some clients have more than $5 million in investable assets and about one-third of his overall clientele now utilize a 529 plan. One such client had made a lot of money as a sales executive in a technology company and decided to liquidate some of his incentive stock options. The client, who has two children, put $35,000 apiece into Colorado's advisor-sold "Scholars Choice" 529 plan late last year, allowing him to save more than $3,000 dollars in state income tax and to set aside college savings for his family at the same time.

Keith Newcomb, a wealth manager and AIF with Full Life Financial LLC in Nashville, Tenn., observes that clients can multiply the typical gift tax exclusion under 529 plans. Consider a family with a grandma and grandpa with two married children, each with two children of their own--four grandchildren.

There's $12,000 in annual gift tax exclusions for Grandpa giving to Grandchild One, and Grandma also has $12,000 in gift tax exclusion for Grandchild One, he points out. "Each grandparent can use five years' worth of annual exclusions all at once." For the family described above, both grandparents could invest a combined $480,000 into accounts for all four grandkids this year.

What about the per-state limits per child? Newcomb would simply stack the limits of two or more state plans: "One state might be $200,000 and one state $230,000; now your limit is $430,000," he explains. Again, better safe than sorry: "It's important to have a reasonable basis for high funding levels--anticipation of undergraduate, graduate, and PhD or specialized medical degrees, for example."

Another new 529 incentive involves qualifying for federally funded financial aid for college: As of July 1, 2006, UGMA/UTMA assets held within a 529 savings plan will no longer be included with other student-owned assets in the formula for determining a family's "expected contribution" towards college costs.

"What used to count against aid eligibility at the rate of 35 percent will now be assessed at no more than 5.64 percent of value," according to the Web site "If you are looking for financial aid, assets in a 529 are considered parental assets," observes D'Angio of College Invest, and parents are expected to contribute 5.64 percent of their assets.

In the final analysis, however, perhaps the most useful feature of the 529 is its "port-in-a-storm" practicality. Beneficiaries may shift with changing plans and educational goals. And "Who knows," McCarthy says: "If we go through another economic meltdown, clients may find that they need the 529 funds for their own retirement."

Janet Aschkenasy ( is a freelance writer who wrote about Baby Boomers in the June issue.

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