Section 529 Plans (College Savings Plans)

Overview

As higher education costs continue to soar, many parents find themselves faced with the nagging question, "Will I have enough money to pay for my child's college education?" Although most people today are likely to agree that an investment in higher education usually reaps its rewards in higher long-term earnings-and hopefully, greater job satisfaction-one key concern is how to choose a smart savings alternative.

One often overlooked option is a state-sponsored qualified tuition program (a 529 plan). These plans offer attractive tax benefits while allowing you to contribute substantially higher sums than with other savings vehicles, such as education IRAs and custodial accounts. The funds may generally be used for any "qualified" higher education expense, including tuition, room, board, fees, books, supplies, and equipment. You don't necessarily need to be a resident of a state to participate in its 529 plan (selecting a state plan where you are not a resident may limit your ability to take advantage of any available state income tax exemptions or state deductions for contributions that your resident state offers). In some states, you may even name yourself as the beneficiary, if you are planning to further your education sometime in the future. However, participation does not guarantee admission to college-the prospective student will still have to meet the school's entrance requirements. 

Although many details of these plans vary by state, they generally come in two forms. The first form - prepaid tuition programs - allow participants to "lock in" tuition rates at eligible state colleges or universities with a lump sum investment or monthly installment payment. The funds are pooled and invested over the long term, so the earnings should meet or exceed expected future tuition increases. The contract value may also be applied to private or out-of-state schools (although possibly not at full value, depending on the state). The second form - savings programs - allow contributions to vary. The full value of the account can be applied at any accredited institution of higher education nationwide. 

Major Advantages

• Substantial Contributions Allowed. Contribution limits are significantly higher than with other college savings alternatives. Some states allow you to set aside over $100,000 per beneficiary, and they generally have no age or income restrictions (contributions are treated as a gift to the named beneficiary for gift tax and generation-skipping transfer tax purposes).

• Tax Benefits. Earnings grow tax deferred until withdrawn, at which point they will be taxed at the child's usually lower tax rate in 2001. In addition, some states offer their own tax breaks. In contrast, traditional custodial accounts do not offer tax-deferred growth.

• Special Estate Planning Features. Contributions to 529 plans are subject to gift and generation-skipping transfer taxes. However, a unique feature of these plans is that they allow you to transfer up to $50,000 out of your estate ($100,000 for a married couple) by using five years' worth of annual gift tax exclusions in one calendar year as long as no additional gifts are given to that individual during the 5-year period. Also, unlike with a custodial account, you retain control of the account. Beneficiaries generally have no rights to the funds. You decide when and for what purpose funds are withdrawn (although you may be assessed a penalty for a "nonqualified" withdrawal).

Other Considerations

• Professional Asset Management. 529 plans offer a "hands-off" savings approach. Funds invested in the plan are professionally managed through the appropriate state treasurer's office or by an outside investment firm hired by the plan.

• Penalty for Refunds. A federal 10% penalty (for 2001) may be imposed on the earnings portion of a nonqualified withdrawal. Perhaps even worse, the earnings on nonqualified withdrawals are taxed at your tax rate and not the student's. However, you may be able to roll over the account to a new beneficiary to avoid a nonqualified withdrawal.

• Effect on Financial Aid. Any investment may affect a student's eligibility for financial aid. Interested organizations are attempting to clarify exactly how 529 plans will affect federal financial aid. For many families who earn less than $50,000 and file 1040EZ or 1040A tax forms, a 529 account may not be counted at all. Others, in higher income brackets, may want to open the account in the parents' names, since financial aid offices typically count only 5.6% of parental assets compared to 35% of the student's assets. For more specific information, refer to the particular state plan that interests you.

Worth "Studying"

Those considering establishing a 529 plan should be aware that the recently passed Economic Growth and Tax Relief Reconciliation Act of 2001 makes several generally favorable changes to federal law governing 529 plans. Since 529 plans also operate under individual state laws, costs and details vary by state. For more information, and to compare state plans, do a little "homework" and visit these web sites: Savingforcollege.com and Collegesavings.org.

No guaranteed rate of return. Out-of-state plans may have in-state income tax ramifications.

Other Section 529 information

• Section 529 - The Best Way to Save for College

• Section 529 - An Overview

• Education Funding Comparisons

Contact Us

If you would like more information about Section 529 plans, please contact us at 888-669-4883, or email us at .