529 College Savings Plan

Passbook savings plans. Custodial accounts. Education IRAs. UGMAs. UTMAs. 529 Plans. Each offer a way to save for the education of one of your loved ones. But which is the best for saving for a child's college education? That depends mostly on your situation and needs. In light of the recent tax changes, 529 Plans (named for the tax code they were written on) may very well be the best option for you. "The new legislation has changed that, by making 529 plan withdrawals tax-free if the money is used for college costs. Suddenly, these plans may indeed be the best deal in college savings." Jonathan Clements, The Wall Street Journal

What is a 529 plan?

Quite simply, 529 plans are college-savings plans, sponsored by state governments, which allow money earmarked for college to grow tax deferred. Distributions for qualified college costs are generally Federal income tax free, and in some states like Oregon, state income tax exempt as well.

More specifically, 529 plans allow those who are contributing the money to ensure that the money indeed goes to education. That means the owner maintains constant control of the account, even after the child reaches legal age. What's more, the owner can change the beneficiary to another family member of the original beneficiary and will only be penalized if the money isn't used for qualified college expenses.

Click here for more on 529 plans

Should I invest in a 529 plan?

That depends on a variety of factors, most particularly income and desired annual contribution. For example, under the new tax code, an education IRA excludes joint filers with income above $220,000. But it's the contribution amount that is so impressive. While education IRAs have been dramatically improved under the Economic Growth and Tax Rate Reconciliation Act of 2001 (click here) starting in 2002 you can contribute $2,000 annually and many state 529 plans let you contribute more than $100,000.

Why should I invest in a 529 plan?

While the tax package is complex, the bottom line is, there are 5 new key benefits to using a 529 plan for saving for a child's college education. (The provisions of the new tax law are scheduled to expire on December 31, 2010, unless extended by Congress.)

1. Tax-Free Withdrawals

   Starting in 2002, all qualified withdrawals from 529 Plans will be federal tax free. This new tax-free status can help maximize a family's ability to meet the cost of college. In addition, this change may have a positive effect on a student's eligibility for financial aid since withdrawals will no longer be considered income to the student.

2. Adjustment of Limitation for Room and Board

   The tax code increases the amount that can be used for qualified room and board expenses. New limitations are directly tied to the room and board costs for housing owned or operated by the eligible educational institution.

3. Member of Family to Include First Cousin

   The new tax code also expands list of family members to include first cousin of a beneficiary. And, it allows grandparents to change beneficiaries among grandchildren.

4. Coordination with Education Savings Accounts

   The new tax code allows contributions to Coverdell Education Savings Accounts, (formerly Education IRA) and 529 plans for the same beneficiary in the same year. And there is no more excise tax on combined contributions.

5. Rollover Between 529 Plans

   The new tax code permits owners to transfer assets from one 529 plan to another once every 12 months for the benefit of the same beneficiary. Plus, it allows for greater portability of college savings assets and increased flexibility to select among program providers.

While these and other provisions of the new legislation are largely favorable, they add complexity to college savings planning and broader financial and estate planning. What's more, there are considerable factors to consider before determining which college plan is right for you. Check with your Financial Advisor to determine which type of college saving plan is right for you, the benefits of estate planning, and leaving a legacy.

529 plans offer terrific tax advantages for both owner and beneficiary but one should not overlook the most obvious advantage of a 529 plan which is that the tax advantages belong to the owner. That means, in addition to the owner having the ability to make sure that the assets indeed go towards education, the money placed into the 529 plan is removed from the donor's estate. This can help to significantly reduce estate taxes.

As Jonathan Clements of The Wall Street Journal points out: "While both (Coverdell Education Saving Accounts) education IRAs and 529 college-savings plans will likely hurt your financial-aid chances, education IRAs currently appear more damaging. An education IRA is considered the child's asset, and thus counts against you more heavily in the financial-aid process. By contrast, a 529 plan is considered the owner's asset."

Click here for Frequently asked questions about 529 plans.

Click here for Information on Coverdell Education Savings Accounts

Click here for more on 529 plans

529 plans pro and con

Advantages

• Money can be used for any college in the U.S.
• May be state tax breaks for contributions.
• Tax-free distributions for qualified expenses (tuition, fees, books, supplies, required equipment, room and board) Click here for definition of expenses
• Can still claim HOPE and Lifetime Learning Credits as long as the payout from the 529 plan isn't used for the same expenses for which credit is taken.
• Can roll over to another plan once every 12 months for same beneficiary.
• Can roll over more often than once every 12 months if changing beneficiaries to another family member. Family members include child, grandchild, sibling, step siblings, parents, grandparents, stepparents, nieces, nephews, cousins, aunts, uncles, in-laws, and spouses.
• Can gift up to $55,000 a year per child without triggering gift tax (gift assumed to be $11,000 ratably over five years). Effectively removes this money from your taxable estate (if you die within five years, a portion may be included in your taxable estate). If you gift split with your spouse, you can get $110,000 out of your estate without triggering gift tax.
• Can contribute to both an Coverdell Education Savings Account and a 529 plan starting in 2002, but watch out for gift tax consequences if you contribute more than $11,000 per person in the same tax year.
• Can contribute more than $55,000 a year and use increased unified credit to offset gift tax on $1,000,000.Check with each state plan to verify the maximum contribution.(Arizona - $177,000; California - $124,799 to 174,648; Nevada - $246,000; Oregon $250,000; Washington has a state run program)
• Donor retains control of account. If beneficiary doesn't go to college, donor can get his/her money back although they would owe tax on the earnings and a 10% penalty.
• No earnings restrictions.
• Since donor owns these accounts, beneficiary may be eligible for more financial aid than if the child owned the account.
• No limited enrollment period.
• No date by which the funds must be used.
• Some states will allow you to contribute by using your credit card. You may be eligible for rewards from your credit card company (up to any monthly cap on rewards.)

Some disadvantages are

• Must use investment options available within the plan.
• You could lose money.
• Expenses of the plan may be higher than what you'd pay if you invested the money yourself.
• A non-qualified withdrawal (used for purposes other than specified education expenses) will be taxed on earnings and will incur a 10% penalty. Exceptions to the penalty include death or disability of the beneficiary or if the beneficiary receives a scholarship. Plans may limit contribution amounts.
• Since donor owns the account, it may be tapped by Medicaid if the donor should need nursing home care and not have other funds available.
• Not all states have protections against donor's creditors.

If you think a 529 plan is the way to go, you should contact your financial advisor to look at the plans in your own state or the state in which the beneficiary lives. You might also look at http://www.savingforcollege.com.

The Worst Reasons for not having a 529 Plan

There are a lot of different options for college savings available to investors. But state-sponsored 529 savings plans are increasingly becoming the most popular option. Not only do the 529 plans have numerous tax benefits, but they also offer high contribution limits and tremendous flexibility to parents. As an introduction to how the plans work, we would like to dispel some common myths you may have heard regarding the limitations of the plans.

IF you are not sure you have enough money to start contributing to a plan, consider that many of the plans can be opened with an initial contribution of just $25. And for people who have trouble saving up money for contributions, payroll withdrawals starting at $15 are available in the plans offered by TIAA-CREF, Fidelity, Alliance, Putnam, and Waddell & Reed. No matter what financial goal you're planning for, getting started early will greatly improve your chances of getting there.

IF you feel that the tax benefits aren't really that meaningful; consider that not only do your savings grow on a tax-deferred basis, qualified withdrawals can be made tax-free. The benefit of tax-free withdrawals is set to expire at the end of 2010, but even if congress does not extend it, and it does expire, savings will keep growing on a tax-deferred basis, and withdrawals will get taxed at the beneficiary's rate.

IF the plan in your state doesn't look very good, consider that while there may be an additional tax break for staying with the program in your state, nearly all plans (for example: Arizona, California, Nevada and Oregon) welcome out-of-state residents. That means that investors need to shop around for the best available plan. Before signing up, parents should compare expenses of the plan, investment options available, and the quality of the professional managers who will invest your contributions.

IF your children will probably end up attending an out-of-state university or a private college; there are no restrictions that force them to attend in-state schools with state-sponsored 529 savings plans. There is a consortium of Independent Colleges and Universities with an Independent 529 plan. Click here for more on 529 plans including Independent plan.
click here for list of schools by state. Even some foreign universities qualify.

IF your children are only interested in technical or vocational schools, you should know that withdrawals for technical schools, community colleges, and vocational schools are covered by 529 plans.

IF you don't want to lose control of those assets because you may need them for unexpected emergencies; understand that these plans can be revoked at any time, although there is a 10% to 15% penalty on gains of non-qualified withdrawals.

IF you don't expect all of your children to attend college; you may change beneficiaries at any time. So if one child goes directly to the work force, you can name another child or grandchild as a beneficiary.

IF you don't like the fact that you can't change investment options within my state's plan; consider that while it is true that there have been strict rules about switching between the investment options within a single plan, it has become easier to roll over assets to another state's 529 plan that may meet your needs. And lawmakers are easing the restrictions within the plans as well, so there's a good chance this rule will go away altogether.

IF you feel that you make too much money to be eligible for 529 plans you should know that unlike with Education IRAs, no one is excluded from contributing to a 529 plan because his or her income is too high.

IF You have checked out the 529 plans, but you feel they all seem too complicated; Contact US at Advanced Corporate Planning or your financial advisor. It's better to get started early than delay and miss out on letting your savings compound over time. If you find a better 529 plan later, you can transfer your savings.

For more complete information on a specific 529 plan, please read the plan's offering statement. It must be provided to you for free and contains important information such as terms and conditions, charges, and expenses. If you are considering a 529 plan from another state, you should investigate whether your state offers a plan with alternative tax advantages for its residents. Monies invested in 529 plans are subject to market risks and are not guaranteed by the state or Federal government or any governmental agency.