Question: Years ago, my wife and I created a college savings account for our daughter. The account made some gains, and we accumulated a considerable amount of money over the years for her college tuition and expenses.
We expected that the fund would run out of money over the course of four years of college, but she ended up attending a government-run school where the tuition was completely paid. She graduated a couple of years ago and is now 24 years old and working full-time. She doesn’t have any plans to return to school at this time.
So, we are left with the funds in the college savings account, and we are wondering what the options are with the money in the account.
Answer: Given the high cost of tuition, having any money left over in a college savings account is one of those pleasant problems you rarely hear about. It is similar to your auto mechanic calling you up to say, “It’s going to be a lot cheaper than we thought.” But this wonderful situation is one that leaves you with the question about what to do with the money.
What type of college savings plan you have will determine the choices you have with the money. The most widely recognized and popular college savings plan is the “529 Plan.” However, Coverdell Education Savings Accounts were created eighteen years ago, and are similar to 529 accounts. They work like a tax-deferred retirement account for qualifying educational expenses.
The 529 Plan offers the ability to make larger annual contributions that the Coverdell. But both 529 plans and Coverdell accounts have the same key feature. They allow for contributions to grow tax-free, and distributions will not be taxed upon withdrawal so long as the funds are used for certain qualified educational expenses. Coverdell Accounts offer a broader definition of qualified expense for K-12 educational expenses, while 529 accounts are limited solely to K-12 tuition.
Relevant to your inquiry, the plans have key differences in what you can do with them once the beneficiary grows older. Coverdell accounts belong to the beneficiary, and if they are not already distributed, they must be distributed by the time the beneficiary turns age 30. What earnings remain in the account will be subject to a 10% penalty and taxed as ordinary income to the beneficiary. In contrast to Coverdell accounts, the person who contributes the money to a 529 plan actually owns the account, and 529 Plans do not have a date by which the account must be distributed.
Without any required date by which the 529 plan has to be distributed, it is possible to allow the account to continue to grow. So, one option you have is to do nothing with the account, and you can “wait and see” whether your daughter changes her mind and returns to graduate school.
If she is resolute in not continuing her education, you may want to also “wait and see” if you would like to transfer the account to another beneficiary. For example, if she decides to start a family in a few years, you can transfer the account to your grandchild. In fact, there are a wide variety of family members to whom you could transfer the account. There may be some tax consequences from the “generation skipping transfer tax” that arise from transferring the property to your grandchild, but the imposition of this particular tax occurs only after the transfer of significant sums of money, usually in the millions of dollars.
If the account is a Coverdell account, you can roll the account over to a 529 plan that offers more flexibility. Assuming that the account is already a 529 plan, your best move may be to hold on to the account to see if you can find a use for the funds that is most tax efficient. It may be that your daughter will return to school even after telling you she won’t, or perhaps a grandchild appears in a few years. Either way, you should be able to find the best fit.
Preston Morgan is a partner at Kopper, Morgan & Dietrich, a Davis law firm providing family law, estate planning and trust litigation representation. His column is published every other week in the Davis Enterprise. To pose a question to Preston Morgan, contact him at https://kopperlaw.com.
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