You�ve probably heard or read of them - state ponsored 529 college
savings programs. There are others available as well; the newly
enhanced Education IRA and the old favorite, UGMA and UTMA accounts.
Determining which type of savings plan is right for you depends on
several factors. Among them: your income, the child�s age and how much
you�ll be relying on financial aid. In some cases, your best option may
be to take advantage of more than one account. I�m going to focus on
the 529 today.
Let me begin by sharing a great website with you.
It is www.savingforcollege.com and is authored by Joe Hurley, It is
full of timely, pertinent information and articles that will expand on
what I�m writing here.
The recently passed Tax Cut made
tremendous improvements to higher education finance. The new law
substantially raises the amount that can be contributed to education
accounts. It�s increased the number of people eligible to save and
makes 529 plans even more appealing. Currently, earnings accumulate on
a tax-deferred basis and withdrawals from these accounts are taxed at
the child�s rate. Starting in 2002, they will be free of federal taxes!
Yes, you read that correctly, tax-free withdrawals (if it�s for
qualified educational expenses).
529 plans are named for the
section of the tax code that created them in 1996. The vast majority of
the plans allow nonresidents to participate, which means you can choose
virtually any state�s plan regardless of where you live or where your
child is likely to attend school.
Unlike Education IRAs, 529s
have NO income limits or age restrictions, so anyone can participate.
You could even set one up for yourself. Some plans will let you invest
more than $200,000 per beneficiary, and there are no annual limits.
And, if your child doesn�t end up using the money � maybe she�s
received a full scholarship � the assets can be transferred to a
sibling or first cousin.
You, as a parent, could open a 529 for
your children, and grandparents could have one for the same children.
You, the donor, are the owner of the account. Your child is the
beneficiary. You remain in control of the monies over the account�s
lifetime. You decide when withdrawals are taken and for what purpose.
If your child uses some of the funds for higher education and is
through, with money to spare, you can name another beneficiary and
start the routine all over again. As long as the beneficiaries are some
form of blood family member you can change beneficiary as needed.
The
changes to 529 plans that begin next year could literally buy you an
extra year of college. Let�s say you invest $60,000 in a 529 plan for
your son. Assume the account doubles in value by the time he heads off
for school, representing a $60,000 gain. Under the previous rules that
profit would have been taxed at the child�s 15% tax rate, reducing the
account by around $9,000. That�s nearly a year�s worth of tuition and
expenses at a public college. Now, that $9,000 stays available for
tax-free withdrawal for those same expenses.
So what if your
only beneficiary decides not to go to school? There�s no time limit on
this account, you could change the beneficiary to your spouse, who
always wanted to return for his/her Masters. You could let it sit and
grow while the child works for a few years and then decides to go to
school, or if not that, decides to get married and has a child of their
own.
You could then change the beneficiary on that account to
your newest grandchild and it lives still in its tax-deferred state.
And if you are feeling generous, you could change ownership of the
account to your child (who is now fully grown and very responsible). Of
course, there may be gift tax consequences to that last part, so don�t
do anything without checking with us. The point is that it is flexible.
Worst
case, what happens if your child doesn�t go to college, or if there�s
more in the account than is ultimately needed? Federal law requires
that the 529 plans charge you a penalty if a withdrawal isn�t used to
pay qualified higher education expenses. Based on IRS guidelines, most
states will collect a penalty of 10% of the earnings portion of the
�nonqualified� withdrawal. This means you�ll get back 100% of your
principal and 90% of your earnings.
That penalty, however,
will be charged at your income tax rate not the student. The penalty is
usually not charged if you terminate the account because the
beneficiary has died or become disabled or if you withdraw funds not
needed for college because the beneficiary has received a scholarship.
The
gift and estate tax treatment of an investment in a 529 plan is, to
quote Joe Hurley, �a good news, bad news situation�. The bad news is
your contribution is treated as a gift to the named beneficiary for
gift tax and generation skipping transfer tax purposes and so you need
to be aware of this exposure especially if you are making other gifts
to the beneficiary during the same year.
The good news is that
your contribution qualifies for the $10,000 annual gift tax exclusion
and so most people can make fairly large contributions without
incurring the gift tax. If you make a contribution of between $10,000
and $50,000 for a beneficiary, you can elect to treat the contribution
as made over a five calendar-year period. This allows you to utilize as
much as $50,000 in annual exclusions to shelter a larger contribution.
The money (and the growth of your account) gets out of your estate
faster than if you made the contributions every year. There are more
details to be discussed if this applies to you, but I�m sure you get
the idea.
There�s more to know especially about the potential
impact on financial aid qualifications and the sunset provisions
inherent in this new tax law. If you are interested in discovering if a
529 plan makes sense for you or your family, please email or give the
office a call.
Beverly Cox, IAR