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529 plans can be a powerful savings and tax-planning vehicle to finance higher education, although there are some additional considerations for US expats. When using a 529 account, after-tax money is contributed to the plan, account growth and income is exempt from federal and state income tax as long as it is used for qualified higher education expenses and the account owner retains control of distributions, changes in beneficiary and the naming of a successor owner. 529 plans are subject to both US federal and state gift and income tax rules. The constructive ownership of the account has no parallel in most tax systems outside of the US.
529 plan issues fall into four broad categories: establishing the account, contributions, tax treatment of account principle and earnings in the account, and distributions.
Establishing an account:
529 plans are established in a particular US state under that state’s rules as well as federal rules. To establish a 529 account, many plans require either the account holder to have a US residence at the time the account is established; residence requirements are not placed on beneficiaries. If you are planning to move overseas it is recommended that you establish 529 plans before leaving the US. If. you are already living overseas you may consider having a trusted family member establish the account for the benefit of your children. But remember: the account holder has the right to change the beneficiary (a qualified relative of the beneficiary) or to relinquish the holding of the account to someone whom you did not designate.
CONTRIBUTIONS:
Contributions under $14,000 (2014, 2015) per tax year are not subject to US gift taxes and up to five times that amount can be front-loaded using up five years of annual gift tax exemption. Contributions above this level are subject to US federal gift reporting and either a gift tax or a reduction of the lifetime exemption. Contributions to a 529 plan may have gift tax considerations in foreign jurisdictions.
INCOME TAX TREATMENT:
While funds remain in a 529 plan , they are not subject to US taxes. Outside the US, earnings inside the account could be subject to local income or wealth taxes (on the account holder or beneficiary depending on local interpretation). One consideration for expats moving to a foreign jurisdiction could be to change the account holder from themselves to a trusted family member (e.g. a grandparent) who will remain a US resident. The IRS does not have a restriction on who the account holder is changed to since the idea is that the account holder/owner will not benefit from the account; they act more like a trustee, which is not limited under the law. Here’s an IRS link for general 529 information: http://www.irs.gov/uac/529-Plans:-Questions-and-Answers
DISTRIBUTIONS:
529 plan distributions of both principle and earnings will not be taxed in the US as long as they are used for the beneficiary’s qualified education expenses, which include tuition, fees, books and supplies at any accredited institution. There are in face over 350 qualified institutions outside of the US in dozens of countries; a full list can be found at this link using the state “FC” for foreign country: http://www.savingforcollege/eligible_institutions/
529 plan distributions of income (not principal) that are not used for qualified education expenses are subject to US and potentially foreign income tax and a 10% withdrawal penalty in the US to either the account holder or the beneficiary, whichever one benefits from the withdrawal.
529 plan distributions of income and principle for educational purposes may be subject to income or gift taxes in a foreign jurisdiction. Tax advisers may look at how a particular jurisdiction treats foreign trusts when seeking guidance for handling 529s. Practically speaking, many individuals and advisers may choose not to report these accounts in a foreign jurisdiction, especially if their stay is intended to be relatively short and the account values and earnings are modest. As more countries exchange account and tax information, including US obligations under FATCA, we could see US-based account of all sorts subject to tax challendges outside the US.
SUMMARY
Because US expats remain subject to US tax laws, 529 plans remain attractive unless it is unlikely their children will attend a qualified institution. Establishing 529 plan accounts and maximizing contributions before moving to a foreign jurisdiction is often recommended. Many non-US-based educational institutions are eligible for 529 withdrawals, but if the beneficiary decides to attend a college that does not qualify, the 529 plan can be used for another family member. The biggest potential downside is the tax treatment of the account in a foreign jurisdiction, although a change in the account holder to a US resident may mitigate this risk. A final consideration is that 529 plans are US dollar-based accounts, so if you plan to send your children to a non-US institution, even if it is qualified, you will be taking some currency exchange risks too.
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