Q&A: This 529 college savings plan has a problem: no kids

Dear Liz: When I found out I could save for my future children by enrolling in a 529 college savings plan and not pay taxes on the growth, I started doing that three years ago. Since then I got married, and my wife decided to get an MBA. I have $41,000 saved away for my currently nonexistent children. Am I able to transfer that money to my wife and use it to pay for her MBA without getting penalties?

Answer: Yes.

The beneficiary of your 529 plan is not actually your unborn children, since you can’t open these plans for nonexistent kids. When you started the account and were asked for the beneficiary’s Social Security number, you probably provided your own.

That could have created a small problem down the road when you did have kids because changing the beneficiary to someone one generation removed — from parent to child, for example — is technically making a gift, and gifts in excess of $15,000 per recipient per year are supposed to be reported to the IRS using a gift tax return. Fortunately, you wouldn’t actually owe any gift tax until you’d given away several million dollars above that annual limit.

By contrast, changing the beneficiary to a family member in the same generation — from yourself to a spouse, for example — is not considered a gift and wouldn’t trigger the need to file a gift tax return.

Q&A: State tax breaks for 529 plans

Dear Liz: You recently answered a question from grandparents who were contributing $20,000 to their grandson’s college education. You correctly told them they did not qualify fdownloador federal education tax credits or deductions because he was not a dependent. You might let grandparents know, however, that they may get a state tax break for contributing to a 529 college savings plan.

Answer: Most states that have state income taxes offer some sort of a tax break for 529 college savings plan contributions. (The exceptions are California, Delaware, Hawaii, Kentucky, Massachusetts, Minnesota, New Jersey and North Carolina, according to SavingForCollege.com. Tennessee has a tax on interest and dividends but no 529 tax break.) In some states, even short-term contributions qualify for a deduction, so grandparents could contribute money that’s quickly withdrawn to pay qualified higher education expenses and still get the break. SavingForCollege has details on each state’s tax benefits.

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