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Which comes first: The kid or the 529 account?

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When Sara Stanich was pregnant for the first time, her unborn child already had a college savings account.

Stanich had received a gift from her in-laws and wanted to put the money toward college savings. She looked at the rules for 529 accounts, which allow for tax-free growth on savings for qualified higher education expenses, such as tuition, textbooks and room and board. While 529 accounts require a Social Security number for the beneficiary, Stanich quickly realized that she could set up the account in her own name and transfer it to her child later.

As the owner of Stanich Group, an RIA in New York, Stanich now shares this story with clients and recommends they do the same. She’s found several takers.

The numbers show that parents are eager to open 529 accounts as early as possible. Of the 371,730 college savings accounts opened in 2016, 41% named beneficiaries under the age of two, according to data from Ascensus.

Some parents may find that opening an account prior to birth makes the most sense on their second or third child, as was the case with a client of Melissa Ellis, founder of Sapphire Wealth Planning in Overland Park, Kansas. While the parents awaited their second girl, “there wasn’t a lot that they needed in terms of baby things,” says Ellis. Instead, they encouraged college donations.

By having the account open before the child is born, parents can funnel “welcome to the world” gifts into tax-advantaged savings. The money will have more time to grow and can be invested more aggressively in those early years, says John Gugle, principal at Alpha Financial Advisors in Charlotte, North Carolina.

Parents or grandparents who want to give a lot at once can also front-load these 529 plans. Individual gifts are typically capped at $14,000 per child per year, but an IRS rule enables the transfer of up to five years’ worth of gifts to a 529 account at once without triggering a gift tax.

Clients may be wary of over-committing to college savings accounts before the child is even in grade school. The earnings on any distributions that are not used for qualified expenses are subject to state and local taxes, as well as a 10% penalty. But given the cost of college and relative ease of transferring beneficiaries, “a lot of people are willing to roll the dice,” says Gugle.

New tax legislation, which is currently being hashed out by Congress, may also expand 529 plans to extend beyond college expenses, allowing up to $10,000 per year, per child to be used for private, parochial or homeschool K-12 expenses. House Republicans had also proposed new rules that would have allowed unborn children to be named as beneficiaries of 529 plans, but Senate Republicans have since removed that provision from their version of the legislation.

Even so, parents can still use the method that Stanich followed and set up an account with their Social Security numbers and later change the beneficiary. “People think that there’s a rule against it or there might be a cost,” Stanich said, but as she found, the process involves little more than a form and no associated fee.

Ellis realizes that some advisors may feel awkward in suggesting that parents open a 529 account before the beneficiary is born. But doing so gives family members a chance to contribute in meaningful ways—especially older generations who may not be around during those college years.
Moreover, advisors who initiate the conversation can build goodwill with their clients, Ellis says.

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