I have a problem I hope you can help me with. I’m a widow; my husband died a few years ago. My husband and I were married for over 30 years. We had no children; however, my husband had a daughter from a previous relationship who lived with us. Eventually she got married and had a child, and at that time we set up an education fund for the child through the Michigan Education Savings Plan. Ever since my husband passed, I have had major issues with my step-daughter, particularly about the estate. She took me to court and lost, and since then she has refused to allow me to see my grandchild. I even consulted with an attorney to see what rights I had, if any. The bottom line is, I’ve decided to cut all ties with that side of the family. My question is what, if anything, can I do with the education fund that I’ve established for my grandson? Since I no longer have a relationship with him, I see no reason why he should have the money for college. Therefore, what options do I have?
You do have a number of different options with regards to your Michigan Education Savings Plan. The first option is to change the beneficiary. According to the rules, an account owner of a 529 Plan can change the beneficiary at any time without tax consequences when the new beneficiary is a family member of the current beneficiary. The definition of a family member is very broad, and not only includes the beneficiary’s blood relatives, but also relatives by marriage and adoption. I mention this option, although I do not believe it will apply to you based upon the information you provided me with.
Another option is to leave the money within the 529 Plan with the idea that if your relationship with your grandchild changes in the future, the money will be there to assist in his future education needs, such as if decides to go to grad school or for continuing education purposes.
The third option is to terminate your Michigan Education Savings Plan and take a distribution on the money. By doing this there would be a tax consequence to you, including a potential penalty. The way the law works is that if you decided to close the account, it would be considered a non-qualified withdrawal. What that would mean would be that you would pay taxes at your ordinary income bracket of the earnings portion of the distribution and in addition, you would be subject to a 10 percent withdrawal penalty. For example, if you’re original contribution to the Michigan Education Savings Plan was $10,000 and today the account is worth $14,000, if you took a withdrawal, your tax would be based upon the $4,000 gain that you have. The $4,000 would be taxed at your ordinary income bracket and then there would be a potential 10 percent penalty on the $4,000. The 10 percent penalty is waived if the beneficiary of the 529 Plan attended a U.S. Military Academy, receives a tax-free scholarship, dies or becomes disabled.
In the situation at hand, depending upon the earnings portion of your account and your tax situation, you may consider closing out the 529 Plan half this year and half next year. In this way you could spread the tax consequences out over two years.
Unfortunately, situations such as the aforementioned are not unusual and they do happen. We all know that family dynamics can be difficult, and emotions always run high. That is why when a situation involves families, I always tell people they need to take a step back and make decisions based with a clear mind. You don’t want to let emotions dictate your decision. Just like when it comes to investing, I always remind investors that if you let fear and greed dictate your decisions, you generally will make the wrong decision. It is the same thing when it comes to family dynamics – you need a clear mind to make the most appropriate decision.
Rick is a fee-only financial advisor. If you would like Rick to respond to your questions, please email him at Rick@bloomassetmanagement.com.