A column on personal finance prepared by the Virginia Society of Certified Public Accountants
GET UP TO SPEED ON SECTION 529 PLANS
(August 20, 2003) – Paying for college is burdensome for many families, but saving for college may be getting easier, thanks to the Section 529 college savings plan. According to the Virginia Society of CPAs, these state-sponsored plans offer significant tax benefits and other advantages.
Tax Breaks Top the List
Contributions to a 529 savings plan are not federally tax-deductible; however, the earnings grow tax-free. Distributions from 529 plans are tax-free too, as long as the money is used to pay for qualified higher education expenses. Qualified expenses include tuition, room and board, fees, and books. One caveat: At the present time, the tax-free withdrawal treatment applies to distributions made between the years 2002 and 2010. However, it is anticipated that Congress will extend this tax break past 2010.
Flexibility Is Key
Each 529 plan is sponsored by a state, but you are not limited to the plan(s) offered by the state you live in. Regardless of what plan you choose, your child can attend any college or university in the country. In fact, you can live in one state, open a plan offered by a second state, and have your child use the funds to attend college in yet another state. However, since residents are sometimes offered special incentives – such as state tax deductions or even matching funds – it pays to look locally first.
In most cases, the flexibility of the 529 plan allows you to freely change the beneficiary on the account. This means that if one of your children decides not to attend college, you can simply transfer the account to another child or other relative, or even to yourself if you plan to go back to school in the future. There are no taxes or penalties involved in such a transfer. You really need only one 529 plan for your entire family’s needs. You can start with your oldest child, and keep changing the beneficiary to the next scholar in line – although specific rules apply to these situations.
However, if you do not use the proceeds of the 529 plan for education, federal tax law requires that the earnings portion of the amount you withdraw be taxed as ordinary income. In addition, there is a 10-percent penalty on the portion of the distribution included in gross income.
No Income Restrictions and No Annual Cap
Generally, there are no income limitations for opening a Section 529 plan. Everyone is eligible to participate and the amount you can contribute is substantial. In fact, many state plans allow you to contribute up to $200,000 or more per beneficiary.
Since most plans have no annual cap, it’s possible to contribute $11,000 each year ($22,000 if both spouses contribute) without triggering any gift taxes. In fact, you can bunch five year’s worth of gifts ($55,000 to $110,000 with your spouse) and contribute the total amount to a 529 plan in one year. This option often appeals to grandparents who are looking to reduce the size of their estates while assisting their families with educational expenses.
Investment Options Vary by Plan
529 plan contribution options are typically flexible and investment minimums are generally low. Most plans allow you to invest a lump sum, deposit funds periodically, or sign up for an automatic investment program, which deducts a specified amount from your bank account, typically on a monthly basis.
Each state selects a financial services firm to professionally manage the plan. The number of investment options varies by state, with many offering investment choices called age-based portfolios that focus on your time horizon. This means that when your child is younger, the plan invests more aggressively. As the child gets older, the plan gradually moves your assets to more conservative investments.
When control is an issue
In a custodial arrangement, such as a Uniform Gift to Minors (UGMA) account, upon reaching the age of majority (18 or 21, depending on the state you live in), the beneficiary becomes the owner of the assets. That means your son or daughter can choose to spend the money on a new Harley rather than a Harvard education. With a Section 529 plan, you remain in control of the plan’s assets. You decide how and when the funds are distributed.
The Importance of Shopping Around
With so many plans available and so many differences among them, it’s important to shop carefully for the 529 plan that best meets your needs and circumstances. According to CPAs, the key factors you should consider in selecting a 529 plan are flexibility, investment options available, and the funds’ performance. And while all plans charge a fee for managing the plan’s assets, be aware that some fees are significantly higher than others.
The Virginia Society of CPAs is the leading professional association dedicated to enhancing the success of all CPAs and their profession by communicating information and vision, promoting professionalism, and advocating members’ interests. Founded in 1909, the Society has nearly 8,000 members who work in public accounting, industry, government and education. This Money Management column and other financial news articles can be found in the Press Room on the VSCPA Web site at www.vscpa.com.
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