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529 Plans

 

Section 529 Education Savings Plan

The cost of a college education can be staggering. Total expenses at private universities currently average more than $43,000 a year*. The annual cost for public universities averages about $19,500. For many families, qualified tuition programs – also called Section 529 education savings plans – are an attractive way to help meet future education expenses.

How Section 529 Plans Work

Section 529 plans are education savings programs sponsored by states, and are authorized by state agencies or eligible public and private educational institutions under Section 529 of the Internal Revenue Code. You can contribute to a Section 529 plan regardless of your annual income or your age, and your contributions can be for the benefit of a grandchild, niece, or nephew, as well as your own child. You can even fund a 529 plan for yourself.

With a 529 plan, you either invest a lump sum or make periodic contributions to an account set up for a designated beneficiary. While different programs do place limits on lifetime contributions, most limits are in excess of $200,000, and many are greater than $300,000. The plan account is professionally managed according to an investment program you set up when you make your initial contribution. When the student is ready for college, generally you – not the student – withdraw the amount needed to pay qualified education expenses, such as tuition, room and board, supplies, and equipment.

Enhanced Tax Advantages

Money invested in Section 529 plans grows free of federal income tax and possibly state income tax for participating residents in many states. Some states also allow you to deduct contributions to Section 529 plans for state income-tax purposes, up to certain limits, if you participate in your own state’s program. (Nonresidents may not receive the state tax advantages afforded to residents.) In addition, the plan investment managers can move money between different investments as needed with no immediate income or capital gains tax consequences, something you can’t do with a regular investment account.

As long as the money is used for qualified educational expenses, payouts from both state and college-sponsored plans are free of federal income taxes. This tax benefit was scheduled to expire at the end of 2010, but the Pension Protection Act of 2006 made it permanent. So, if you’ve been reluctant to invest in a 529 plan for a young child because of the tax uncertainty, you might want to reconsider. Withdrawals for anything other than qualified education expenses are subject to income taxes and generally are subject to an additional 10% federal tax penalty, as well.

Investments in Section 529 plans qualify for the federal gift-tax annual exclusion up to certain limits. This exclusion lets you make tax-free gifts of up to $14,000 a year ($28,000 if your spouse agrees to join in your gifts) to each of as many people as you choose. A special “front loading” tax provision allows you to contribute up to $70,000 in one year to a 529 plan and treat the contribution as if it were made ratably over five years so it qualifies for each year’s exclusion. Thus, you and your spouse could contribute as much as $140,000 in one year for each of your children or grandchildren, free of gift tax.

The money you invest in a 529 plan, as well as all future appreciation on that money, generally is removed from your estate for estate-tax purposes. However, if you make the five-year/$70,000 “front loading” election, and die within five years of the election, a prorated portion of the contribution will be included in your estate. Using the annual exclusion to make gifts to grandchildren has generation-skipping transfer (GST) tax advantages, too. No GST tax will be applied to contributions that qualify for the annual exclusion.

Portability

Money can be transferred tax deferred from one qualified tuition program to another qualified tuition program for the same beneficiary once every 12 months. Other transfer rules vary from state to state. If the designated child decides not to attend college, you have the option of changing the account beneficiary to another family member. Family members include the beneficiary’s spouse, siblings, first cousins, children, nieces, nephews, and their spouses. Take care, though, when changing beneficiaries. Gift and GST taxes could apply if the new beneficiary you name is a generation below the old beneficiary.

More Favorable Financial Aid Calculation

A 2006 tax law change positively affects how 529 plan assets figure in the federal student aid calculation. Before the law changed, the Free Application for Federal Student Aid (FAFSA) counted a 529 prepaid tuition plan as a resource that generally offset aid eligibility dollar for dollar. In contrast, a 529 college savings plan was reported as an asset of the account owner (typically, the parents). For aid purposes, parents are expected to use about 5.6% of their assets for college expenses. (Student assets are counted more heavily.)

Under the change in the law, both types of 529 plans are treated as parent-owned assets, which potentially qualifies a student for greater aid than if the assets were deemed student owned. In the case of a 529 plan created (and, thus, owned) by a grandparent, the plan assets generally do not have to be counted in the aid calculation at all. The 2006 change also allowed dependent students to exclude self-owned 529 plans from the FAFSA calculation. But not for long. The College Cost Reduction and Access Act, signed into law in the fall of 2007, provides that, starting with the 2009-2010 school year, dependent students will no longer be able to exclude these assets from the FAFSA calculation. Instead, student-owned 529 plans will be treated as parent-owned assets.

Choosing the Right Plan

To find out which states offer qualified tuition programs and get general information about them, here are a couple websites to check: www.savingforcollege.com or www.collegesavings.org. Carefully refer to the program brochure or offering memorandum and prospectus for complete investment information on objectives, risks, fees, tax benefits and expenses. These documents should be read carefully before investing. Note that your choice isn’t limited to the program offered by your home state.

The risk with investing for college is that the investments may not perform well enough to cover the rising cost of college expenses, as anticipated. The investment return and principal value of an investment will fluctuate with changes in market conditions so that an investor’s shares when redeemed may be worth more or less than the original amount invested. Before choosing a plan, you should talk with a professional financial planner. He or she can help you evaluate the many programs available.

Certain benefits may not be available unless specific requirements (e.g., residency) are met. There also may be restrictions on the timing of distributions and how they may be used. Before investing, consider the investment objectives, risks, and charges and expenses associated with municipal fund securities. The issuer’s official statement contains more information about municipal fund securities, and you should read it carefully before investing.

*Average Published Undergraduate Charges, 2015-2016, Trends in College Pricing 2016, trends.CollegeBoard.org

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