In the United States, post-secondary education is expensive, and most Americans with college educations now start their professional lives in debt. This adds needless stress to their lives, as well as pressure to pursue career paths that may not reflect their (or your) values. Perhaps you are banking on how your child will be a star athlete, get a full ride for being an amazing scholar, or you just plan on sending your child to Germany for free tuition.
The goal is to save and invest money and have plenty of cash by the time your child grows up and is ready to ask for it. If they end up not needing the money, you can use it for other things.
Congress came to the decision to encourage savings for education by offering tax incentives. What I want to discuss in this post is the 529 plan. I will leave other methods of saving for another day.
There are two kinds of 529 plans; one 529 plan is essentially prepaid tuition. This is where you lock in tuition at a particular academic institution. This will have very limited appeal for most parents. The second is a savings plan, where every state has its own sponsored plan. For example, California has the ScholarShare savings plan administered by TIAA-CREF.
This is savings for a specific purpose, a narrow one at that. Not every child goes to college, and indeed, not everyone needs to. Plenty of successful people have never attended a postsecondary institution, or have found their success through alternative educational resources. Some children use a whole lot more of their parent’s savings by being in school longer than other children or attend much more expensive institutions. Some will use less for other reasons, for example, they may have more scholarships and grants available to them.
So when you begin crafting a college savings plan, you want to be able to have the flexibility needed to move assets from the benefit of one child to another. Another option is if the money is no longer needed for your children’s education, you can use it for their wedding, a gift towards your child’s first home, for a vacation, or for whatever you wish.
Furthermore, ideally, if you went through some financial problems, or you went through a lawsuit or even bankruptcy, your children should still be able to go to college without going into debt.
Advantages of 529 Plans
Here are some advantages to the 529 Savings Plans.
- Anyone can donate to it (so grandparents).
- You can change beneficiaries as many times as you want.
- It can be outside your taxable estate for estate and gift tax purposes.
- It can be protected from bankruptcy, depending on who the beneficiaries are.
- Withdrawals can be free of federal or state taxes if used for qualified educational purposes (this is fairly broad but not unlimited).
- You can get the money back, just pay taxes and penalties on the earnings (not on the principle).
- There are no income limitations. You can be wealthy and still participate in this program.
- You can save as much money as you want in these plans, as long as it can be reasonably used for educational purposes. Some plans do have limits however, but they are quite large.
- You can “roll over” a 529 plan into another one you like better without any penalty or taxes.
- It has minimal impact on your child’s financial aid application. FAFSA in particular, which only takes into account 5.64% of parent’s assets and counts 529 plans as a parental asset.
There are some caveats to these benefits (this is a mere blog post, I am writing more about it elsewhere) however if you have children you expect to be paying college bills for, and are blessed enough that you can save some money, this likely sounds like a great deal.
The 529 Savings plan does have one gigantic drawback that will make it a deal breaker for many Muslims. You cannot control the investments in the plan. That is to say for those who insist on “Sharia-compliant” investment products will not find them useful.
This plan is also one of many devices that is treated as your money for some purposes, and not treated as your money for other purposes. So 720 days after funds are deposited into your account and the beneficiary is a child or grandchild (step children and step grandchildren count as well), the asset is treated as essentially not being yours if you go through a bankruptcy. It is also not your own for estate and gift tax purposes if it is structured properly.
However, the money is your own (assuming you are the account owner) for other purposes. You can decide who gets the money; you can even give it back to yourself. Also, after death, the successor account holder needs to be named. The 529 account does not just disappear or get distributed to the beneficiaries. If you do not name a successor account holder, the 529 plan becomes a probate asset. This means a judicial process will determine how it will be distributed.
So if you have this kind of account, for purposes of the Islamic Rules of Inheritance, it is your money. You should pay zakat on it every year unless you have actually distributed it to a beneficiary. If you die before your children are educated it needs to be distributed based on the Islamic Rules of Inheritance, and not based on the educational needs of the children. So in that sense, it is treated exactly like any of your other accounts. The Trustee can provide educational benefits to those who need it without regard to inheritance rights so long as other beneficiaries are compensated with other assets.
My suggestion is that you name the Trustee of a Revocable Living Trust as the successor account holder. Then instruct the Trustee on how to handle the asset, assuming the 529 plan administrator allows this. This is based on contract and not state or federal law.
Check out my document on mistakes Muslims make in their Living Trust.