Extreme College Planning

Most parents aren’t looking forward to the cost of sending their kids through college. For those of you who really want to get a head start, here’s a scheme that will help maximize your college savings, albeit via rather quirky means.

Some time ago, a friend approached me with a question that no one had ever asked me before:  Is there a way to establish a tax-favored college savings plan for a child who hasn’t been born yet?  As it happened, he and his wife were planning to have a child within a year or so.  They had some cash that was uncommitted and they were looking to kill two birds with one stone: start saving for college and avoid income taxes on the funds, too.  My first thought was to put the money in a Roth IRA.  Since contributions (just contributions, not earnings) can be removed from a Roth tax-free at any time, that would be one approach.  Mind, you, I don’t really like the idea, but it was my first thought.  Alas, they make too much to contribute to a Roth.

Just as I was about to conclude that there was no way to set up a “pre-natal” 529 college savings plan, an answer hit me.  You may change the beneficiary of a 529 plan as long as the new beneficiary is a relative of the old beneficiary (subject to the rules of the specific 529 plan).  In this case, the parents could contribute the surplus funds to a 529 plan, naming one of the parents as the beneficiary.  After the child is born, the owner (one of the parents) could change the beneficiary to the child, and poof, the plan is for the child now.

Because this involves tax law, there are a few details to keep in mind.  In order to avoid gift tax consequences (yes, you can be taxed for giving too much money away), the amount in the account at the time of the beneficiary change should not exceed the annual gift tax exclusion, currently $12,000, or $24,000 if there are two parents.  Actually, up to five years’ worth of gifts can be given tax-free at one time if you file the proper tax paperwork (Form 709), but few people are in a position to give that much at once.

Admittedly, starting college savings for an child before she’s born is a bit extreme, but in some ways it makes a lot of sense.  Couples often find that whereas they had no trouble saving money pre-child, it becomes much harder post-child.  Putting the money aside before a child is born could be easier than saving later, at least psychologically.  This approach also maximizes the time that the money has to grow prior to college.

If 529 plans are unfamiliar to you, take a look at an older post on things you should know before investing in a 529 plan.

About the author

Thomas Fisher, CFP®

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