Saving for college

by Tim Foster

Your Guide To 529 Plans

Many major purchases and investments are made during your lifetime; however, is there any investment more important than the one in your child’s future? With the ever increasing cost of higher education and the possibility of multiple children and multiple degrees–or the six year plan for the four year degree–the need for planning has never been so important. Therefore, why not set up a plan while the future student is still a toddler? A plan parents, grandparents and other relatives can contribute to during the life of that student. Better yet, what if the contributions could be made without gift tax consequences and could grow tax free? Well, the good news is they can! Here is how...

In 1996, Congress created Section 529 plans. Named after the IRS code that created them, Section 529 plans permit:

• Flexibility when choosing a school
• Transferable savings from the state in which the plan was established to academic institutions in other states and countries
• The opportunity for late starters to make large "catch up" contributions
• Tax breaks on contributions, growth and withdrawals

Who is eligible?
Everyone is eligible. There are no income or age restrictions.

Do I have to pick a college when I set up the plan?
No. Unlike prepaid tuition plans that allow you to pay for a college education at today’s tuition rate, 529 plans offer the flexibility of allowing the student to choose the school. The school does not need to be located in the state in which the plan is established. Students can also pursue opportunities which allow them to study in foreign countries.

Will savings in a 529 plan have an impact of future financial aid?
Assets accumulated in a 529 plan are considered the property of the individual who opened the account. A financial aid office will typically focus initially on the student’s assets. Colleges require the student to contribute a greater percentage of his or her assets towards the tuition bill, so a 529 plan would have less of an impact on financial aid.

How much can I contribute?
To avoid gift tax consequences, and the requirement to file a gift tax return, annual contributions should be limited to annual gift tax limits. Currently, an individual can gift $12,000 ($24,000 when made jointly with a spouse) to one future student in any year without triggering federal gift tax consequences. The "catch up" feature for late starters allows for an accelerated five-year gift of $60,000 to be contributed all at once (per beneficiary) without triggering gift tax. Total plan contributions vary by state, but most permit each potential student to accumulate in excess of $200,000.

Can I contribute stocks, bonds or mutual funds directly to a 529 plan?
No, unfortunately only cash contributions are permitted. Other assets must be converted to cash before they are contributed.

How does the money come out?
When the child reaches college age, monies can be withdrawn for payment of qualified college expenses including tuition, fees, books, room and board and certain other eligible expenses. Withdrawals from qualified plans are tax free. Any monies remaining in the plan can be used by another designated beneficiary such as a sibling, first cousin or other defined relative. Money withdrawn for purposes unrelated to education is subject to a 10 percent penalty and ordinary income tax treatment.

Does the account become the property of the child when they reach college age?
No. The 529 plan is not a custodial account the student gains control of when reaching the age of 18 or 21 (depending on the state). The account owner decides when and how the funds will be used. If the funds are not used by the intended beneficiary, the account owner can deicide who can use them based on the plan’s rules.

Can I determine how monies will be invested?
Not directly, but each state plan utilizes an asset management group; so, after comparing various state plans, you can decide which group is best to manage your plan. You do not need to reside in the state you choose; however, before deciding on a particular out-of-state plan, check with your tax professional to ensure you are not missing out on a state tax benefit. While plans vary by state, your investment will generally be divided into a specific asset allocation based on the child’s age. Though investment risk is reduced as the child nears college age, the investment returns are not guaranteed. To check specific state plans for asset management and contribution limits visit www.savingforcollege.com.

Are the savings in the 529 plan subject to fees and expenses of the plan?
Yes, you can expect to pay enrollment, annual maintenance and/or fund expense fees. Compare the fees charged by the particular state before investing, as they can vary greatly.

What are the specific tax advantages of a 529 plan?
Although contributions are not federally tax deductible, some states do allow a full or partial deduction. The benefit of a 529 plan is that contributions within the gift tax limits discussed previously are not considered the child’s income and have no gift tax ramifications to the contributor. The funds’ earnings grow tax free, and distributions for eligible expenses are tax free. The Pension Protection Act of 2006 has permanently extended benefits that were scheduled to expire in 2010.