How to Create a 529 Plan Before Your Kids Are Even Born

Saving for education can help minimize future student loan debt. Money you save now can grow and have huge benefits for your children down the road.

In this video from the Motley Fool Live Financial Planning series, longtime contributor and Director of Investment Planning Dan Caplinger discusses the pros and cons of 529 plans and what’s involved in changing from one beneficiary to another. Dan points out that there may be some gift tax consequences in some cases, but there are some novel strategies you can use if you want to get an early start on college savings even before you start a family.

Dan Caplinger: Zach: “Hey, Bro and Dan. I’m 30 years old, married, no kids yet. College graduate living in New York. Can I create and contribute a 529 in my name, get the state tax deduction, and then, once I have kids, shift those 529 contributions to my kids without penalty, even though I never ended up going to graduate school?”

I believe the answer is yes. You’ll want to take a look at the plan specifically to make sure you don’t run afoul of any restrictions. But I’m not aware of anything in the 529 rules, as is, that prevent you from making this. You know, you can open a 529 for yourself. That’s a definite thing. As you say, you may go back to school someday, and if you go back to school, you’re going to need that money in order to pay tuition. You can use that tuition at that point.

The thing to keep in mind is, at the time that you change the beneficiary from yourself to a child that you may have in the future, you’re going to want to pay attention to potential gift tax consequences of that. I believe that that change of a beneficiary may have some gift tax implications in terms of, effectively, you’re giving the whole 529 balance from yourself to that other beneficiary. But I’ve got to check on that, because I’m not sure if the beneficiary designation by itself does that. But that is one caution I would have. Other than that, totally good strategy.

Robert Brokamp:  A follow-up question related to that from El Al: “Could you give us a few do’s and don’ts to setting up a 529 for my newborn?”

So I’m going to put in the chat a great website, savingforcollege.com. I think you should always start with your own state and see how that plan is related, because many states do give, as Dan mentioned in the previous question, some states do provide deductions under state income tax return — not federal, state return. It might be worth looking into that. But you don’t have to stick with your state’s return, and if you save often, there’s a limit. Like in Virginia, I think it’s $ 4,000. So you could contribute, if you’re going to save more than $ 4,000, you contribute $ 4,000 for Virginia plan. Then if you don’t like Virginia’s plan — although the Virginian plan is actually very good — you can go to another state’s plan. There’s technically contribution limits to 529s, but they’re very high. They’re in a hundreds of thousands of dollars.

So start with your state’s plan first. Then the next thing to do is Saving for College rates plans, as does Morningstar. Morningstar rates 529 plans. Look up the resources to see how plans are rated, and see if you’ve got a good one. Most of them are pretty good these days. It really comes down to cost: cost of the account and cost of the investments.

Dan Caplinger: Following up with Zach, I did take a look. It looks like the IRS is looking at some regulations that let you do some beneficiary changes without gift tax implications. But the requirement is that they will be in the same generation. Basically, it’s a situation, if you have multiple kids, you set up a 529 for one kid. That kid doesn’t use up all the money. You’re like, “Well, kid No. 2 needs some money. Why don’t I change the beneficiary there?” That would be a non-gift tax event under these regulations.

But for you to change it to your child, different generation, it does look like those gift tax consequences might be there. So just something to keep in mind. Obviously, I don’t think that the New York tax deduction is all that huge. There’s probably a pretty low limit on it. So you’re probably not talking about an amount that really has all that big of a gift tax consequence anyway. But yeah, just something to think about.