While driving to pick up some treats from the bakery early Sunday morning, I happened to tune into American Public Media’s Marketplace Money on local NPR affiliate WUNC-FM and hear Jill Schlesinger provide answers to caller’s financial questions. [i]
I’m a fan of Schlesinger. Not only is she the Business Analyst for CBS News and the host of the nationally syndicated radio show “Jill on Money”, she’s one of the rare personal financial commentators who has obtained the CERTIFIED FINANCIAL PLANNER™ professional designation. But on this program, as she was in the process of giving some very good advice to a soon-to-be parent, I heard her give a technically true yet still incomplete answer.
The expectant father’s baby wasn’t due until August, and he had asked if it made sense to open and contribute to a 529 College Savings Plan. As long-time blog readers know, 529 Plans are one of the better options for saving for college, as gains are tax deferred and can even be tax free if withdrawals are for qualified higher education expenses, such as tuition, fees, books, and room and board.
After stressing the importance of contributing the maximum to retirement plans before thinking about education savings (and using the financial planner maxim that loans are available for college but not for retirement!), Jill said that the caller couldn’t open a 529 Plan until his child was born because the child didn’t yet have a Social Security number.
It’s true that a 529 Plan application requires the Social Security number of the designated beneficiary of the account (i.e., the person for whom account funds will be used for higher education expenses). And it’s also true that Social Security numbers aren’t assigned to people until they are born. But none of that prevents anyone from opening a 529 Plan that will eventually be used for the benefit of a baby not yet born.
That’s because the owner of the 529 Plan (technically called the Participant) can change the beneficiary whenever he/she wants. And as long as the new beneficiary is a family member of the old beneficiary, there are no income tax consequences. So, the expectant father could have opened a 529 Plan account and named himself or his wife as the beneficiary, and then changed the beneficiary once they’d obtained a Social Security number for their child.
Technically, when someone names a new beneficiary of a “lower” generation than the old beneficiary (as in the example above), the IRS considers this to be a gift from the first beneficiary to the second. This means that theoretically changing the beneficiary could result in gift and generation skipping taxes, depending on the exact beneficiary change taking place. But considering that the annual gift tax exclusion amount is $14,000 in 2014, it seems unlikely that such a large dollar amount could accumulate in the few months prior to the child being born to actually trigger either tax.[ii]
In fact, some expecting parents might consider opening a 529 Plan account and encouraging people to contribute to it rather than buy cute but incredibly temporary baby clothes. As most new parents will tell you, the most adorable baby outfits tend to be the most impractical. Alternatively, parents who already have one child might think about opening a second 529 Plan using the name of their first child as the beneficiary, and then switching it to their new child upon his/her birth.
Woodward Financial Advisors is a proponent of 529 plans for education savings. Despite the elimination of the North Carolina state tax deduction for residents’ contributions to the North Carolina plan, 529 College Savings Plans continue to be one of the most tax efficient ways to save for college. They also appear to be one of the few accounts where you don’t even need to be born yet to start reaping the benefits!
[i] Marketplace Money airs on WUNC-FM at 7 AM on Sunday mornings. For those who can’t quite bear to turn the radio on that early, podcasts of previous shows can be found at http://www.marketplace.org/money
[ii] Please consult your tax and financial advisor if you are considering changing the beneficiary of a 529 Plan account worth more than $14,000 in 2014 to someone in a lower generation than the current beneficiary.