Advanced Underwriting Consultants

Ask the Experts – May 7

Ask the Experts!

The professionals at Advanced Underwriting Consultants (AUC) answer the tax and technical questions posed by producers.  Here’s the question of the day.

Question: My client wants to help her grandson save for college. The grandson’s parents have already started a Section 529 qualified tuition plan (“529 plan”) for the benefit of her grandson. Can she contribute money to this pre-existing 529 plan?

Answer: Yes, but only if the 529 plan allows third party contributions. Additionally, there are potential hazards in making a third-party contribution to a 529 plan.

The IRS says that whoever purchases the 529 plan is the custodian and controls the funds until they are withdrawn. Since the grandmother didn’t start the plan, she doesn’t control it; therefore, she would lose access to the funds that she contributed. If she started her own 529 plan for the benefit of her grandson, she could still control the funds, allowing her to access them if she needed.

Additionally, since 529 plans typically allow the account owner (here, the parents) to access the funds, they could potentially withdraw third party contributions unless the plan provides otherwise. If there are no safeguards against it, the beneficiary might never see the grandmother’s contribution.

Finally, a contribution to a 529 plan is ordinarily treated as a gift to the beneficiary. But the IRS hasn’t addressed whether third-party contributions should be treated as two gifts—one from the third party to the account owner, and a second from the account owner to the beneficiary. If the account owner maintains control of the 529 plan, an argument can be made for this type of treatment.

Most 529 plans allow third-party contributions, but if the plan doesn’t, your client would want to find another way to help her grandson save for college. This could include opening a separate QTP for the benefit of her grandson. Additionally, your client may want to avoid potential problems with third-party contributions, so it might be wise in certain situations to start a separate 529 plan.

Have a question for the professionals at AUC?  Feel welcome to submit it by email.  We may post your question and the answer as the question of the day.