A change in how a child's interest, dividends or other unearned income is treated makes it prudent to think of switching the assets producing that income into a tax-advantaged 529 college savings plan. Congress made the 529 permanent this year; i...
A change in how a child's interest, dividends or other unearned income is treated makes it prudent to think of switching the assets producing that income into a tax-advantaged 529 college savings plan. Congress made the 529 permanent this year; it was set to expire in 2010.
Under the old law, parents of a child age 14 to 18 could transfer assets to an account in the child's name and count on the first $850 being tax-free. Anything more than that was taxed at a rate of 15 percent or less, rather than at his parents' rate, which can be as much as 35 percent.
Starting this year, however, children up to 18 get a tax break on $1,700 in unearned income. The first $850 is still tax-free, and the next $850 will be taxed at the rate of 15 percent or less. But anything more than $1,700 can be taxed at the higher parental rate.
Anyone with children around age 14 who had been counting on the old law should consider transferring those assets into a new 529 plan opened in the child's name. The money can't be rolled into an existing 529 plan if that plan is in a parent's name because assets, once given to a child, have to stay in the child's name to avoid questions about whether the initial gift really was a gift and to avoid any potential transfer taxes.
The child might have to sell assets from another account before putting them into the new 529. That could trigger a capital gains tax, but if the child has owned the assets for a year or more, the rate is likely to be at a child's rate of 5 percent, still less than the rate his parents would pay. Money put in a 529 account grows tax-deferred and becomes tax-free if withdrawn to pay for college. Another benefit to having a 529 college fund in a child's name: Starting this year, these funds aren't considered when applying for federal student aid.
How much a person can contribute each year varies from state to state. But to avoid federal gift taxes, each parent can contribute no more than $12,000 a year on average over five years to a 529 plan in a child's name.