529 Education Savings Plans
Do you have a child or grandchild who is going to attend college or trade school in the future? Are you concerned with how to pay for their education? If so, you are like many of us that desire our children or grandchildren to continue their education and are concerned with how to pay for it.
You have may have heard about qualified tuition programs, also known as 529 plans (named for the Internal Revenue Code section that provides for them). 529 plans allow prepayment of higher education costs on a tax-favored basis, by deferring or even completely eliminating the taxes on any earnings of the account. You can think of it as a Roth IRA for education.
Types of 529 Plans
There are two types of programs:
Prepaid plans allow you to buy tuition credits or certificates at present tuition rates, even though the beneficiary may not be starting college for some time. Prepaid plans were popular when first introduced, but have declined in availability; and
Savings plans that allow the account owner to make contributions and earn a return until the funds are withdrawn at a later date.
How 529 Plans Work
Contributions are not deductible for federal income taxes however, many states offer credits and deductions for contributions to state-sponsored plans. Using a state-sponsored plan doesn’t limit the beneficiary to attending school in that state. Most state plans offer great investment choices with low investment costs. The website www.savingforcollege.com publishes information on states offering credits and deductions for 529 contributions.
The earnings on the account aren’t taxed while the funds are in the program. Beneficiaries can be changed on the account and account owners can rollover the funds in the program to another plan for the same or a different beneficiary without income tax consequences.
Distributions from the program are tax-free up to the amount of the student’s qualified higher education expenses. These include tuition, fees, books, supplies, and required equipment. Reasonable room and board is also a qualified expense if the student is enrolled at least half-time.
Distributions in excess of qualified expenses are taxed to the beneficiary to the extent that they represent earnings on the account. A 10% penalty tax is also imposed.
Eligible schools include colleges, universities, vocational schools, or other postsecondary schools eligible to participate in a student aid program of the Department of Education. This includes nearly all accredited public, nonprofit, and proprietary (for-profit) postsecondary institutions. A school should be able to tell you whether it qualifies.
Contributions made to the qualified tuition program are treated as gifts to the student, but the contributions qualify for the annual gift tax exclusion, which is currently $14,000. If your contributions in a year exceed the exclusion amount, you can elect to take the contributions into account ratably over a five-year period starting with the year of the contributions. Distributions from a qualified tuition program are not subject to gift tax, but a change in beneficiary or rollover to the account of a new beneficiary may be.
529 Plans are a great way to save for a child or grandchild’s education. These plans can yield tax savings since earnings are not taxed if used for qualified education expenses. Many states offer credits or deductions, so it may be beneficial to start a plan to use for paying current post-secondary education expenses. If you are considering how to pay for college expenses of a child or grandchild, consult a qualified tax professional.