College Planning Q&A: 2503 (c) Trusts and 529s

College-savings expert Susan Bart answers advisors' questions on 529 plans and other education-planning matters. E-mail your questions to advisorquest@morningstar.com.

Holiday Gift from the IRS
The IRS has announced that during 2009 it will permit up to two investment changes in a section 529 savings account because of the recent condition of the financial markets. Recall that initially it appeared that an account owner could make a change in investments only if the beneficiary was also changed. Section 529(b)(4) states that a program shall not be treated as a section 529 qualified tuition program unless it provides that any contributor to, or designated beneficiary under, such program may not directly or indirectly direct the investment of any contributions to the program (or any earnings thereon). Notice 2001­55, 2001-2 C.B. 299 created more flexibility. Notice 2001-55 states that it is expected that the final regulations under section 529 will provide that a program does not violate the investment restriction under section 529(b)(4) if it permits a change in the investment strategy once per calendar year and upon a change in the designated beneficiary. The Notice conditioned the application of this special rule upon the program (1) requiring that participants may select only from among broad-based investment strategies designed exclusively by the program and (2) establishing procedures and maintaining appropriate records to prevent a change in investment options from occurring more frequently. The additional flexibility in 2009 may prove useful particularly if financial markets continue to be erratic. Many, however, wish that this flexibility was not expressly limited to only 2009.

This month's column will focus on some specific examples of how section 529 savings accounts can be used in connection with different types of trusts. My article on this topic, 'The Best of Both Worlds: Using a Trust to Make Your 529 Savings Accounts Rock," has now been published by ACTEC Journal (Winter 2008). It is available for purchase on-line at www.actec.org.

Question: Billy Ray has established section 2503(c) trusts for each of his children, Miley, Noah, and Braison. He is now interested in establishing section 529 accounts for each of those three children.

Susan: A section 2503(c) trust is a trust established for a beneficiary under age 21 that meets the requirements in Internal Revenue Code section 2503(c). Gifts to a section 2503(c) trust qualify for the gift tax and GST tax annual exclusions. To meet the requirements of section 2503(c), the trust must be only for one beneficiary, there must be no substantial restrictions on the trustee's ability to make distributions to the beneficiary, the beneficiary must receive the trust assets at age 21 or have a right to withdraw them at such age, and if the beneficiary dies before receiving the trust assets they must be included in the beneficiary's estate for estate tax purposes.