Stern Advice: Should you buy a 529 for your unborn grandchild?

By Linda Stern

WASHINGTON (Reuters) – As publisher of the SavingforCollege website, Joe Hurley is a bit obsessed with 529 college savings plans, so it’s no surprise that he has one in his name and one in his wife’s.

What’s unusual is that he doesn’t expect to use those funds to send his kids to college. One has already completed his undergraduate education and the other is almost done.

Instead, Hurley and his wife are employing a strategy oft suggested by financial advisers: They are creating a family education fund that they will have the flexibility to deploy in any number of ways.

Perhaps one of their children will use those funds for graduate school. Hurley or his wife may even go back to school themselves. Or one day, their 20-something kids might have children of their own, and those future grandchildren could benefit from the 529 plans.

In the meantime, the Hurleys themselves are benefiting from the tax advantages these plans convey. All of the money the plans earn will be tax free if it is used on higher education by a Hurley relative. And, depending on where they live and what plans they own, they may be getting state tax deductions for their plan contributions, too.

Some financial advisers and college financial pros like the idea of having clients start their 529 savings before their intended beneficiaries are born, because it allows them to fully take advantage of compound earnings.

“One of your greatest assets is time,” says’s Mark Kantrowitz, another college savings expert who started 529 plans before either of his children came into the world. “The more time you have, the more you’ll get from interest instead of contributions.”

For example, if you open a 529 plan earning 7 percent a year with $1,000 and put $200 a month into it, you’ll have $89,657 in 18 years. After 25 years, you’ll have $167,740. In 30 years, you’ll have $252,111.

The mechanics of the long-term 529 plan require the plan owner to change the beneficiary designated on the account when giving the funds to someone else. So if you set up a plan for your adult child, and she uses it for her child, you will eventually have to remove your daughter as beneficiary and add your grandchild instead.

There are issues, of course. One is that this multi-generation approach to 529 plans is not something that lawmakers necessarily envisioned when they created the tax breaks for these plans. And what Congress giveth, Congress can take away. So it’s a good idea to have someone in mind for the plan, or have other relatives that you could switch the funds to down the road.

And some people — ahem, me — might be too superstitious to open a financial account for a person who isn’t born yet. In that case, you — I? — could open a 529 plan for adult children who have completed college. They could use the funds to go to graduate school or eventually transfer them to their own children.

Here are some other financial considerations:

— You could save too much. You’re allowed to give $13,000 a year to another person without triggering a gift tax. (And that applies to each spouse, effectively doubling the limit for a couple giving money away.) Federal rules allow you to do five years of 529 funding at once without triggering a gift tax. But changing the beneficiary of a plan is the same as giving a gift. So if the plan exceeds $65,000 when you change the beneficiary, you could end up either owing gift taxes on some of the amount transferred, or reducing the amount you could leave in a tax-free estate down the road.

You can get around that by splitting the 529 into two or more plans, and changing the beneficiaries on them over a longer time period.

If you save so much in a 529 plan that you can’t possibly use it for education, you’ll have to pay a 10 percent penalty on the earnings you withdraw for non-education uses.

— You could take more investment risks. If you’re saving for an event 25 years into the future, you can afford to be more invested in stocks, which typically earn more, than in bonds or bank accounts. If you’re saving for a 10-year-old, you’ve got to start moving the money to a safer, and slower growing, alternative.

— You could hurt your beneficiary’s chances for financial aid. The formulas are complex, but at some level, the 529 plan will reduce the amount of aid a student can get. And you can’t take distributions from a 529 plan for a school expense and then take an education tax credit or deduction for the same expense. But having the money in hand is still better than begging for the money. And with so much aid in the form of loans, having a fat 529 account still will give your eventual beneficiary more options than not having the account.

— You could spend too much in fees. Some 529 plans have gotten a bad reputation for costing too much. There are layers of fees, including costs for signing up, for program management and for investment management. But fees have been falling. Shop for the best plans at Hurley’s site, Saving for College (, or at the College Savings Plans Network site (, sponsored by the state plans themselves, to find a good, low-cost plan.

(The Personal Finance column appears weekly. Linda Stern can be reached at linda.stern(at)

(Editing by Gunna Dickson)

Stern Advice: Should you buy a 529 for your unborn grandchild?