Update on 529 Plans

An Important Part of Paying for College


President Obama recently caused a stir when he proposed abandoning the federal tax incentive on 529 Plans. Parents and grandparents put money aside for college expenses in these tax-advantaged investment accounts, knowing that any increase in those assets is free of federal and state income taxes. In addition, all withdrawals used for qualified higher education expenses are exempt from federal income tax.

Some 35 states also waive state taxes on withdrawals, along with offering other incentives. Since there are about 12 million 529 Plans in existence, many people were upset at the possibility of losing this incentive when they were trying to do the right thing by saving ahead for college. The idea was quickly scrapped, but it has drawn a renewed focus to this piece of the college payment puzzle.

With so much attention focused on the cost of college and the increase in student loan debt, one element that does not get a lot of attention is the 529 Plan. This is a great way for relatives of younger children to put aside money for college - the more you save, the less you will have to borrow when the time comes to select a college. Some benefits of 529 Plans include:

  • Federal tax-free withdrawals for college expenses.
  • Separate plans can be started for each child in a family, but account holders have the ability to change the beneficiary to another member of the family. The account holder retains control of the assets regardless of the beneficiary's age.
  • Assets can be rolled over between plans.
  • Many plans have low minimum monthly contribution amounts. A little money saved on a regular basis over a long time can really add up. The sooner you start saving for a child’s college education, the more money you will have available.
  • Maximum contribution limits are quite high, and often offer the flexibility to cover the entire cost of a college education.
  • Contributions can be made for up to $14,000 per year without incurring a federal gift tax. Account owners can make a lump sum contribution of up to $70,000 per beneficiary (or $140,000 if married filing jointly) by electing to use five years of the annual gift tax exclusion in one year.

Essentially there are two approaches to 529 Plans - savings and prepaid tuition. A 529 Savings Plan is just that. Although they are administered by the states, the account increases or decreases based upon the market performance of the underlying investments. Many account owners choose to invest in certificates of deposit or some type of conservative mutual funds, especially as the child gets nearer to college age.

Prepaid Tuition Plans (or guaranteed savings plans) allow account holders to pre-purchase tuition for their student, based on today's rates. These Plans are paid out when the beneficiary is in college. Currently there are 13 Plans offered by 12 states and one not-for-profit organization.

If your child decides not to attend college, you can change the beneficiary to another member of your family, defer use of the savings and leave your contributions invested in the account, or withdraw the assets in your account for a “non-qualified” distribution.

With this type of withdrawal any earnings, but not contribution amounts, may be subject to state and federal taxes. In addition, there will be a 10% federal tax penalty on the earnings.

529 savings plans can be used at virtually any accredited college or university in the U.S. and at some foreign schools, and are an important part of the total college package.