529 College Savings Plans for American expats living Abroad

By ZM Ishmurzina

The average cost of college education has been constantly rising. Per the US Department of Education, the price to attend a public university has increased 42% between 2001 and 2011. The cost to attend a private institution has increased 31% for the same time period. US taxpayers are advised to start planning for the children’s education in advance. Although, American expats reside overseas, they still have an access to a wide range of college savings plans. Before making contributions to any education savings account, US taxpayers are advised to review their retirement plans like Roth IRA or Traditional IRA for American expats too to make sure that they have a proper allocation.

This is the latest email from one of our clients, American expats living abroad. “I live in Switzerland with a family. My daughter is only three years old. However, I would like to start planning for my child’s education now and would like to learn more about different college savings plans.” The purpose of this article is to provide a summary of the most popular questions about US college savings plans like a 529 Education Savings Account.

529 college savings plans for American expats living abroad

What is a 529 Education savings account?

A 529 education savings account was introduced by Congress back in 1996. A 529 account is an attractive option since the earnings on contributions to the plan grow tax-free. Moreover, if the distributions from the plan are used to pay for qualified higher education expenses, then these distributions are tax-free. The funds from 529 education savings account can be used at any accredited university in the US as well as some qualifying institutions abroad.

Can an American expat living abroad open 529 college savings plans?

Every state has at least one 529 education savings plan. Some states offer several 529 college savings plans. Although, American expats are not residents of any particular state, they can still open 529 college savings plans. American expats will not receive a state tax deduction for the contributions made to 529 education savings account because they’re not required to file a state tax return.

What is a difference between a 529 prepaid tuition program and a 529 savings program?

US taxpayers as well as American expats living abroad can choose between two 529 plans.

The 529 prepaid tuition program is a 529 account that is used to purchase future tuition at today’s rate. Parents, grandparents or any other party can start a prepaid tuition program to pay for the future college tuition. On the other hand, a 529 savings program is the college savings plan because it enables its participants to save money in a college savings account. Any contributions to this college savings plan as well as earnings on the account will be used to pay for qualified education expenses tax-free. Each 529 education savings account offers a wide range of investment options so it is essential to choose the right plan that meets the individual requirements of American expats.

How to choose college savings plans for American expats living abroad?

As with as with any investment plan, it is essential to review three most important criteria.

  1. Low fees. American expats must target low administration fees and passively managed funds.
  2. Investment options. 529 plans should offer a wide variety of investment options to satisfy various risk aversions: 100% equity funds, fixed income funds, stable value funds, as well as a variety of equity and fixed income options, principal protected options and FDIC insured bank options.
  3. “Age-based allocation strategy”. It is essential to adjust the portfolio as the child approaches the college age. Consequently, it is beneficial to choose college savings plans with the age-based allocation strategy in which the age of the beneficiary determines the specific mix of investments.

Can 529 savings plans be used for foreign education institutions?

Per the Federal student aid website the distributions from 529 savings plans can be used to pay for qualified education expenses in more than 451 foreign education institutions. To get a list of all foreign institutions, please go to www.fafsa.ed.gov.

How much can an American expat contribute to the 529 education savings account per year?

Each US taxpayer can contribute up to $14,000 per year per child in 2013. The contribution up to $14,000 qualifies for the annual gift tax exclusion so there is no gift tax return filing requirement. American expats can choose to make a lump sum contribution of up to $70,000 ($140,000 for joint filers) and spread this amount over 5 years to avoid federal gift tax. The advantage of making a lump-sum contribution is a tax-free growth of investment. Consequently, it is better to invest a larger amount as early as possible to generate a higher return.

Are all distributions from 529 savings plans tax-free?

The distributions from 529 savings plans are free if they are used to pay for qualified college expenses. However, any withdrawals for “non-qualified” distributions will be subject to federal taxes, 10% federal tax penalty on the earnings as well as state taxes. One of the ways to avoid this situation is to name a new beneficiary like another child or grandchild.

Do American expats have other college savings plans to choose from?

Americans living abroad can choose from a wide variety of foreign investments. However, they should avoid PFICs or foreign mutual funds because they will be subject to enormous US filing requirements and punitive taxes on their PFIC investments.

Conclusion

Choosing college savings plans might be a challenging task for any taxpayer including American expats living abroad. It is beneficial to review the options online and to discuss investment strategies with a reputable investment advisor.