You can open a tax-advantaged college savings plan, known as a 529 plan, for essentially anyone, including yourself, a friend or relative. You even can change the person the plan is intended for, known as the beneficiary, and in many cases, you can roll funds from one person's plan into another person's plan with no tax penalty. Some people even create 529 plans nominally for themselves, intending to begin saving for their future children, who will be named as beneficiaries later on.
How 529 Plans Work
A 529 plan lets you save money for someone's higher education expenses, including college or vocational school tuition, required fees, room and board. It also can pay for elementary and secondary tuition. You pay federal income tax, as usual, on money that you put into a 529 plan, though some states offer deductions for 529 plan contributions. When you withdraw money for the beneficiary's education, that money, including any earnings, is not subject to federal tax and in some states is exempt from state income tax as well.
Similar to using a Roth IRA to save for retirement, a 529 plan essentially allows you to invest funds to grow tax-free until it's time to use them to pay for someone's education. If you use them for something other than allowed educational expenses, however, you will have to pay tax on the earnings as well as a 10 percent tax penalty.
529 Plan Beneficiaries
When you set up a 529 plan, you designate a beneficiary whose expenses the plan will cover for education. You can change the beneficiary as you wish, perhaps effectively moving money from an account in your name into one in your child's name or moving an account in one child's name to another if one of your children decides not to attend college or earns a scholarship and doesn't need to tap into savings. Multiple people, such as a parent and a grandparent, can open a plan with the same beneficiary.
You also can roll funds from one 529 plan with one beneficiary into a plan with another beneficiary, provided they're related, with no tax penalty.
Saving for Multiple People
If you are opening 529 plans for multiple people, such as multiple children in your family, it's often a good idea to open individual plans for each child. First, this makes it easy to have a separate mix of investments geared toward each person's age and anticipated needs, such as taking riskier investments with greater potential rewards for children with more years to go before college. You also can contribute more to the plans without coming close to your annual untaxed limit, currently $15,000 per recipient.
That strategy also can help in applying for financial aid if some of the saved funds are officially designated for a student's sibling, rather than for the student, though exactly how this works varies from college to college.
The only catch may be if fees are greater for having more than one plan, though there often are ways to avoid this problem. For instance, some plans waive fees for people signing up for automatic deposits to the plan.
- WealthFront: Be Smart About Your 529 Plan Beneficiary and Save More for College
- IRS: 529 Plans: Questions and Answers
- US News: Beware of 5 Myths About Changing a 529 Plan Beneficiary
- SEC: An Introduction to 529 Plans
- Saving for College: Two Kids, Two 529 Plans?
- The Motley Fool: Generation-Skipping Tax: What It Is and How to Avoid It