College education is a major concern for a lot of people. In the economy of today, a college education is a good investment, but very expensive. It is worth the time to save and invest for college expenses. The 529 college savings plan is a saving plan for college and there are advantage and disadvantages to the plan.
529 Plan Overview
A 529 plan is a tax-advantaged investment vehicle designed encourage saving for future higher education expenses of a designated beneficiary. Qualified distributions from 529 plans for qualified higher education expenses are exempt from federal income tax.
529 plans are named after section 529 of the Internal Revenue Code. There can be significant state tax advantages and other benefits, such as matching grant and scholarship opportunities, protection from creditors, and exemption from state financial aid calculations for investors who invest in 529 plans in their state of residence.
There are two types of 529 plans: prepaid and savings.
Prepaid plans allow one to purchase tuition credits, at today’s rates, to be used in the future. Currently, 11 states provide a prepaid tuition plan. Some states have closed their plans to new investments. Prepaid plans may be administered by states or higher education institutions.
Savings plans differ from prepaid plans in that all growth is based upon market performance of the underlying investments, which typically consist of mutual funds. Most 529 savings plans offer a variety of investments based on age of beneficiaries that become more conservative as the beneficiary gets closer to college age. Savings plans are administered by states and although states administer the savings plans, record-keeping and administrative services may be delegated to a mutual fund company or other financial services company.
Use for qualified education expenses
Money from a 529 plan can be used for tuition, fees, books, supplies and equipment required for study at any accredited college, university or vocational school in the United States and at some foreign universities.
The money can also be used for room and board, as long as the funded student is at least a half-time student. Additionally, off-campus housing costs are covered up to the allowance for room and board that the college includes in its cost of attendance for federal financial-aid purposes.
A distribution from a 529 plan that is not used for the above qualified educational expenses is subject to income tax and an additional 10% early-distribution penalty on the gains portion only unless one of the following conditions is satisfied:
· The designated beneficiary dies or becomes disabled, and the distribution goes to another beneficiary or to the estate of the designated beneficiary.
· The designated beneficiary receives any of the following:
o a qualified scholarship excludable from gross income
o veterans’ educational assistance
o employer-provided educational assistance
o any other nontaxable payments (other than gifts, bequests or inheritances) received for education expenses
Advantages to 529 College Savings Plans
There are many advantages to the 529 plans.
First, although contributions are not deductible from the donor’s federal income tax liability, many states provide state income tax deductions for all or part of the contributions. Additionally, beyond the potential state income tax deduction possibilities, a prime benefit of the 529 plan is that the principal grows tax-deferred and distributions for the student’s college costs are exempt from tax.
Next, the contributor maintains control of the account. With few exceptions, the named beneficiary has no rights to the funds. Most plans allow the donor to recover or reclaim the funds for yourself any time you desire, no questions asked.
Additionally, 529 plans provide a very easy way to save for college. Once the decision has been made on which 529 plan to use, all that is needed are a simple enrollment form and a contribution or to sign up for automatic deposits. The ongoing investment of the account is handled by the plan and assets are professionally managed by the state treasurer’s office or by an outside investment company hired as the program manager. 529 plans generally have very low minimum start-up, contribution requirements and low fees. Furthermore, everyone is eligible to take advantage of a 529 plan, and the amounts that can be put in are substantial. Generally, there are no income limitations or age restrictions.
Another rather unusual advantage of the assets in a 529 plan is that although they can be reclaimed by the donor (subject to income tax and the 10% additional penalty on any gains) the assets are not counted as part of the donor’s gross estate for estate tax purposes. Thus 529 plans can be used as an estate planning tool to move assets outside of one’s estate while still retaining some measure of control if the money is needed in the future.
Another benefit associated with 529 Plans is the ability to transfer unused amounts to other qualified members of the beneficiary’s family without incurring any tax penalty.
Disadvantages to 529 Plans
While the number and types of 529 plans is growing, not all investment vehicles are available in 529 form. And unlike other types of tax-deferred plans, such as 401K plans, IRS rules allow only one change or reallocation of the investments per year, in a 529 plan.
The earnings portion of money withdrawn from a 529 plan that is not spent on eligible college expenses will be subject to income tax and an additional 10% federal tax penalty, and the possibility of a recapture of any state tax deductions or credits taken.
The 529 account is counted as an asset that may affect the eligibility of financial aid. If the parent owns the 529 account, then the financial aid office will only take into consideration 5.64% of the entire value; if owned by the student it will also be considered at around 20% of the entire value for calculation. If a grandparent owns the plan, the potential financial aid is not affected.
Other 529 College Savings Plan Concerns
In certain circumstances where a 529 account experiences investment losses, the contributor to the account may withdraw the funds and have the losses deducted from taxable income.
Contributions to 529 plans are considered gifts under the federal gift tax regulations and hence any contributions in excess of $13,000 if filing single or $26,000 if filing married jointly count against the one-time gift/estate tax exemption.
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