My good friend Sean Moore is a Certified Financial Planner and a person I trust implicitly. We’ve recently been having discussions around the intersection of asset protection planning and college financial aid. In the course of these discussions I’ve learned something interesting: Planning to pay for college goes WAY BEYOND filling out standardized forms and hoping you qualify. There are many college financial aid loopholes known only to people like Sean who make it their mission to help families minimize the impact of increased educational expenses.

When you think about the rising cost of education relative to core inflation, it becomes clear that expert guidance in the realm of college financial aid is an absolute necessity. If you have kids in high school, I advise you to contact Sean over at https://www.Smart4College.com. The sooner the better.

Enter Sean Moore . . . .

Most parents and grandparents have heard of a 529 college savings plans. Many have used or are using a 529 plan to save for upcoming college expenses. However, few families truly understand the impact that a properly structured college funding plan can have on their asset protection strategy as well as estate planning strategies.

What is a 529 plan?

Hang on. I have to give you the boring explanation of a 529 before I can get to the good stuff. 529 is a reference to the section within the Internal Revenue Code that set forth the rules and regulations of a qualified tuition program (QTP) beginning in 1996. The code states that a QTP must be established by a state or educational institution and may allow a person to purchase tuition credits for a beneficiary or make contributions to an account for the purposes of meeting the qualified expenses of the designated beneficiary.

There are 2 types 529 plans:

1. A pre-paid tuition plan offered by a state or educational institution
2. A college savings plan operated by a state.

While nearly every state offers some type of 529 plan (many states offer more than one plan), less than a dozen offer a pre-paid tuition plan.

There may be up to three parties involved in creating a 529 plan: The donor, the owner and the beneficiary. While any person may fill one or more roles, most often there are at least two separate parties involved (donor/owner & beneficiary).

Tax Benefits

When used properly, a 529 provides for tax free growth and withdrawals. The investments inside a 529 grow tax free and as long as distributions are made for qualified educational expenses, they are not subject to taxes. Non-qualified withdrawals will subject the earnings in the account to incomes taxes plus an additional 10% penalty.

Money is invested into a 529 plan on an “after-tax” basis which means that there are no federal tax savings on contributions, however, there are often tax breaks on state income taxes if you invest in your home state’s 529.

Asset Protection Benefits

In the case of bankruptcy, assets within a 529 are protected under federal law. If the beneficiary is the child or grandchild (including step children and grandchildren) of the debtor, all assets contributed more than 2 years prior to filing are protected. Assets contributed more than one year but less than two years prior to filing are protected up to $5,000 per beneficiary.

Additionally, state specific creditor protections are in place in at least 27 states with varying degrees of coverage, including claims outside of bankruptcy. The amount of asset protection afforded by a 529 is largely dependent on the plan participant’s state of domicile.

States that protect 529’s from creditors of donor, owner and beneficiary:

Colorado, Florida, Oklahoma, South Dakota, Virginia

States that protect 529’s from creditors of owner and beneficiary:

Alaska, Arkansas, Kansas, Kentucky, Maine, North Dakota, Pennsylvania, West Virginia

States that protect 529’s from creditors of beneficiary:

Louisiana, New Jersey, Wisconsin,

If your state is not listed above, don’t worry just yet. States like Oklahoma and Rhode Island have broad protections in place for 529 plans. While they do not specifically name donor, owner and beneficiary in the statute, the language claims a general exemption which is presumed would protect all three.

Meanwhile, New York statute protects 529 assets if owned by a minor but limits parent and grandparent protection to $10,000.

While one state may offer more asset protection than another to 529 plan participants, how that protection affects participants from an outside state is still uncertain. The question of one state honoring creditor protections of a 529 in another state has yet to be contested in court.  Only three have statutes explicitly protecting 529 assets in other states: Florida, Texas and Tennessee.

Estate Planning Benefits

529 plans have an estate planning benefit unmatched by other investment plans or entity structures. Contributions to a 529 plan are considered a completed gift when the contribution is made and as such are removed from the estate of the donor immediately. While making a completed gift is not a particularly novel concept, the donor may also be the owner of the account retaining full control of the funds held within.

As owner, the donor may move the funds from one plan to another or make investment changes within the account (subject to plan restrictions), change the beneficiary and even withdraw the funds effectively reversing the gift! Don’t try that with an irrevocable trust or UTMA!

Contributing to a 529 Plan

Contributions to a 529 are limited to what is deemed necessary to provide for the qualified higher education expenses of the beneficiary. Most state plans today have a maximum contribution limit of around $350,000.

As mentioned above, contributions to a 529 are considered gifts and are subject to federal gift tax regulations. Like any other gift, up to $14,000 may be contributed this year under the annual gift tax exclusion. The exclusion is double for married couples filing a joint return ($28,000 in 2014).

Another benefit a 529 plan is the ability to “front-load” 5 years worth of gifts. A donor may contribute up to $70,000 ($140,000 joint) and elect to apply the contribution equally toward the next 5 years’ annual exclusions. Any additional gifts made to the beneficiary within the 5 year period would require the donor file IRS Form 709 and may be subject to gift taxes.

For parents and especially grandparents, utilizing a 529 plan (or plans) can go be a helpful tool in reducing the size of their estate, sometimes significantly.

As with any investment, asset planning or estate planning strategy, never rely solely on advice found on the internet. Always consult with a qualified attorney and financial planner to discuss your individual situation. Thankfully, if you are reading this, you know just where to look!