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Florida 529 Plans [Overview, Estate Planning and Florida Medicaid]

Florida 529 Plans

Now, there’s no two ways about it – college is expensive.   Scholarships are great, but they are also highly competitive and might not be available or suited to the student’s career path.  Student loans are, of course, available, albeit much maligned.  And, if at all possible, you want your child or grandchild to come out of school with minimal debt, rather than starting adult life behind the financial eight-ball.  If that’s your goal, you will need to start saving as early as possible. For many parents (and grandparents) in Florida, Florida 529 plans are the single best tool for financially preparing for the costs of higher education.

In general, 529 plans are tax-advantaged investment accounts sponsored by states or state agencies, or by educational institutions.  All fifty states and the District of Columbia offer 529 plans, and a conglomeration of private colleges and universities also sponsor a plan collectively.  The plans are beneficial whether your student intends to attend a public or private school and can also be used for trade and vocational schools.

Types of 529 Plans

There are technically two types of education plan authorized by Internal Revenue Code Section 529 – education savings plans and prepaid tuition plans.  When most people think of 529 plans, though, education savings plans are what they have in mind.  That’s not to say prepaid tuition plans are not useful – they are very useful and usually a great deal.  But they are also less widely available and more restricted in how they can be used.

Education savings plans, on the other hand, are versatile and can be used virtually anywhere, including some colleges outside the United States.  The State of Florida sponsors both a prepaid tuition plan and education savings plans.  Many states only offer the latter, and some of the states that have prepaid tuition plans are phasing them out.

How do Prepaid Tuition Plans Work?

Prepaid tuition plans were started by the State of Michigan in 1986 and enshrined in the tax code ten years later.  The plans allow you to purchase education credits, or “tuition certificates,” in advance for later use by the account’s beneficiary.  The benefit of participating is that you can lock in current tuition rates at the time the account is opened.  Considering how quickly college costs have increased over the last few decades, this feature alone makes prepaid tuition plans a good deal.

Prepaid tuition plans are typically limited to tuition and fees, though a few states, including Florida, allow optional advance payment for room and board.  Most plans let you pay into the plan in installments, so that you can gradually purchase credits through monthly payments over an extended period rather than through a lump-sum payment.  While some plans have a minimum initial contribution, it is usually not very high.  For the most part, additional contributions are discretionary, but, of course, the plan will not do much good if it is not funded.

Most qualified tuition plans are state-sponsored and include eligibility requirements and restrictions.  For instance, states commonly require that either the account-holder or the student reside within the state and limit the use of the prepaid credits to in-state public schools.  If the student opts to attend an out-of-state school, the funds paid into the plan can still be used for education, but without the locked-in tuition rates.  If the student earns a scholarship or decides against attending college, refunds are available, but the pay-out won’t be as high as what would otherwise have been credited toward tuition at a qualifying school.

Although 529 prepaid tuition plans are usually associated with public colleges, a group of over 250 private institutions (including elite schools like MIT, Duke, and Notre Dame) jointly sponsor the Private College 529 Plan, and some individual institutions also have their own plans.  Notably, prepaid plans are only available for higher education and cannot be used for private or parochial elementary or secondary schools – unlike education savings plans.

Florida offers one of the most highly-rated, and the single largest, prepaid tuition plan in the country.  Florida’s prepaid plan is also among the few with an option to prepay dorm fees.  To participate, either the parent / guardian or the beneficiary must be a Florida resident.  And the prepaid credits can only be used at public colleges and universities in the Sunshine State and must be used within ten years of purchase, except that the ten-year period is tolled during any periods of military service by the student.  A participating student who would not otherwise qualify for in-state tuition can get in-state rates through a prepaid plan, as long as he or she attends an eligible school.

How do Education Savings Plans Work?

A 529 education savings plan is an investment account, similar to an IRA, that you use to invest funds for future “qualified education expenses” incurred in providing for the education of a designated beneficiary.   Qualified expenses include not just tuition and enrollment fees, but also room and board, books, computer and other technology costs, and even off-campus rent under certain circumstances.  You can use the funds for essentially any legitimate educational institution, including private elementary or secondary schools, trade and technical schools, and some colleges outside the U.S.  If you use 529 funds to pay for private elementary and secondary school tuition, distributions are limited to $10,000 per year.

Education savings plans are sponsored by state governments but usually have no residency requirements.  So, a Texas resident could theoretically participate in Florida’s plan and vice versa.  Some states do offer specific benefits, like fee waivers, for participating residents and may allow residents to deduct contributions on their state tax returns.  Because Florida has no state income tax, its plan does not provide a tax deduction to Florida residents.

Plans typically have a menu of investment options to choose from, such as mutual funds and target-date portfolios.  Investments within a plan are not guaranteed by the sponsoring states, so there is a risk of investment losses.  However, some investment options (e.g., CD’s) are indirectly guaranteed by the FDIC or other state agencies.  Depending upon the individual plan, the account may incur enrollment and maintenance fees along with management fees for the individual investments.

Florida’s 529 education savings plan is managed by the Florida Prepaid College Board, which in turn retains outside specialists to manage the pooled investments.  The available investment options are similar to what you might expect from a 401k:  money-market, indexed, and mutual funds and comparable investment vehicles.  Florida’s plan does not charge enrollment, application, or maintenance fees, and management fees are limited to around 0.5%, depending upon the investment. Participants can set up recurring, automatic payments for regular contributions so that contributing to the plan requires minimal effort.

Income Tax Implications of 529 Plans

529 Plans are taxed similarly to Roth IRA’s.  The money that goes in has already been taxed, and the money that comes out, including investment earnings, is not subject to any additional tax, provided the funds are used for qualified education expenses.  If withdrawals are not used for qualified expenses, the investment growth is taxed as income and also subject to an additional ten-percent penalty.

You can avoid the penalty if the non-qualified distribution occurs due to one of the recognized exceptions, including the beneficiary’s disability or death.  The penalty also does not apply if the funds were not needed for the beneficiary’s education because he or she earned a scholarship or is attending a U.S. military academy.  If an exception applies, the account growth is still taxed as ordinary income upon withdrawal (similar to a non-qualified annuity) but with no additional penalty.  Both the income tax on growth and the ten percent penalty can be avoided by simply naming a different beneficiary and using the money for his or her education.

529 account contributions cannot be deducted from federal income taxes, but a majority of states allow for either state tax deductions or credits. As mentioned above, Florida has no state income tax, hence no deduction.  In some states, the tax incentives are only available if the account funds are used to attend an in-state school.  If you take a state deduction or credit and end up not using the money for qualified education expenses, you may have to recapture the deductions on a later return.

According to Forbes, higher education costs have risen nearly 500 percent over the past thirty years – more than four times faster than inflation generally.  As a consequence, if you can lock in current tuition rates by enrolling in a prepaid plan while your child is still in elementary school, you can potentially save tens of thousands of dollars on education expenses in the long-run.  Or, if you want more flexibility, you can save and invest tax-free through an education savings plan, and use the money for more or less any college, university, technical, or trade school in the country – and some outside of the country.  Even if your child earns a scholarship and doesn’t ultimately need the money, the investment grows tax-deferred, allowing for reinvestment and greater overall returns.

Estate Tax Implications of 529 Plans

When we’re talking about estate taxes, we are referring to the Federal tax levied on the gross value of the estate that exceeds the statutory federal estate tax exemption amount. Notably, Florida has no state inheritance tax, yet this varies between the states.  Whether a 529 account is “includable” in calculating a donor’s estate can vary depending upon how the account is titled. The safest way to make sure the donation of proceeds to the account is a considered a “gift” for estate tax planning purposes is to change the “participant” of the plan. For parents, this may not be feasible if the child is a minor, so this may be a more effective strategy for grandparents who can change the participant to the grandchild’s parent or guardian. This removes doubt that the 529 account proceeds are NOT includable in the grandparent’s estate. Another important consideration is that if funds were deposited “in trust for” (ITF) the grandchild, they would be included in the grandparent’s estate.

The point is that for a 529 plans to be exempt from estate taxes, certain strategic steps need to be taken. In this way, they have proven to be a great tool for many grandparents who want to proactively save for their grandchildren’s education.

529 Plans and Florida Medicaid

529 Plans and Florida Medicaid Planning

Similar to the estate tax planning analysis, the general rule is if the proceeds in a 529 account can be liquidated and used by the donor, then Florida Medicaid would expect the applicant to use those proceeds to pay for chronic medical care.

The same rules that apply to estate tax planning and gifting, discussed in the paragraph above, also apply to Medicaid planning in Florida. However, keep in mind that gifts are penalized under Medicaid rules if made within the 60-month look back period. So, it is important plan ahead and formulate a great pre-Medicaid plan.

The key in planning is to avoid situations can arise in which a 529 plan is deemed a “countable asset” when calculating Medicaid eligibility.  For example, even though an account is intended to benefit the student-beneficiary, a 529 plan is usually revocable (meaning the account-owner can withdraw the funds from the account).  And, as a result, the value of the 529 plan is counted toward the Medicaid asset limit, potentially impacting the eligibility of the contributor.

Recognizing these conflicting incentives, state and federal governments have enacted some exemptions for 529 plans. No states, for instance, count a 529 account held for a child’s benefit toward that child’s eligibility for Medicaid/CHIP.  Some states, though not Florida, have specifically exempted 529 plans held by a parent for a child from the parent’s Medicaid asset limit.   But, even in states in which 529 plans are countable assets, there are effective strategies for preserving Medicaid eligibility while still helping to fund a child’s future education.

The key to removing 529 plan funds from the Medicaid asset test is to make the funds essentially irrevocable.  That is, the 529 account needs to be set up so that the donor no longer has the ability to take the money back after it is placed in the account.  This can be accomplished most simply by contributing to an account held by someone else.  So, for instance, if you want to help fund your grandchild’s education, you can contribute to a 529 plan held in the name of the child’s parent, rather than in your own name.  The 529 contributions still benefit the student but without affecting your Medicaid eligibility.

Alternatively, a 529 plan can be set up in the name of an irrevocable trust.  Once money is placed in the 529 account, the contributor no longer has any right to access the funds because the trust is the legal owner of the account.  Therefore, the account is not an “asset” for Medicaid purposes.  Similarly, 529 plans held in a custodial status for the exclusive benefit of the student cannot be tapped by the contributor and so are not “assets.”

For left-over 529 account funds in an existing account not used by the student-beneficiary, an applicant can consider liquidating and converting the funds into exempt assets like a Medicaid-compliant annuity, funeral trust or prepaid burial contract, or special needs trust.  Or, liquidated funds can be “spent down” on medical equipment or other non-countable property.

The rules applying to both Medicaid and 529 plans vary in each state.  Florida offers some of the best and most popular 529 plans in the country but has not expressly exempted the plans from Medicaid determinations, unlike some other states.  With the assistance of an experienced Medicaid-planning attorney, though, you can still help fund a student’s future education through a highly beneficial 529 college savings or prepaid tuition plan without jeopardizing your own Medicaid eligibility.

Any way you slice it, for parents and grandparents who want to assist their children in navigating through higher education without getting tangled up in burdensome student loan debt, 529 plans are a strategy that is worth considering.

Steve Gibbs, Esq.