The 529 Plan's official title is Qualified
State Tuition Program and is found in Section 529 of the
Internal Revenue Code, hence the name 529 Plan. It was designed
to provide a strategy to save for the higher education expenses
of a child. Programs are administered by a state agency, or an
organization designated by the state. Plans differ from state
to state. Some states have a plan with no specific residency
requirements that is available to prospective students from any
state. Other state plans are available only to residents. There
are two types of Section 529 plans: prepaid tuition plan
and 529 tuition savings plan. All but one
state, including DC, have one or more operating 529 savings
plans in place. |
There are certain requirements set forth in the
Internal Revenue Code
that apply to all qualified state tuition plans. Among these
are: 1) all contributions have to be made in cash; 2) there must
be a separate account for each beneficiary; 3) there is a
penalty for use of funds for purposes other than educational
expenses of the beneficiary (allowances are made if the
beneficiary receives a scholarship, or upon the death or
disability of the beneficiary); 4) neither contributor nor
beneficiary can direct the investment of the funds; and 5) the
investment may not be used as security for a loan. |
A "contributor" (account owner), establishes an
account for the "beneficiary", usually a child or grandchild,
for the purpose of paying expected college expenses. To
establish this account, the contributor may use the 529 Plan in
his/her state of residence or he/she may use a 529 Plan from
another state that does not have a residency requirement.
Selected mutual fund companies manage most of assets used in 529
Plans. The contributor, based on his/her investment objective,
chooses a specific fund portfolio available within the program
and then makes contributions to the fund according to his/her
wishes. |
An example of how one state runs its program:
There are no residency or age requirements for the contributor
or beneficiary, and the contributor and beneficiary may be the
same person. The minimum initial contribution is a $250 lump sum
or, if the contributor prefers to use an automatic deposit
option, the minimum to start an account is $50 per month.
Maximum contributions for one beneficiary can total $300,000.
There is a 10% federal penalty if the money is used for a
purpose other than the beneficiary's higher education expenses,
unless the beneficiary received a scholarship, or in the case of
the beneficiary's death or disability. Earnings are exempt from
state and federal income tax during accumulation. Funds
withdrawn to pay for qualified education expenses are exempt
from state and federal income tax. The provision allowing for
federal income tax-free withdrawals for qualified expenses will
expire on 12/31/2010 unless extended by Congress. |
The federal tax law makes no stipulation as to
whom the contributor may be, in relation to the beneficiary. The
contributor maintains ownership of the account, until such time
as distribution of funds takes place. The contributor may change
the beneficiary, but the new beneficiary must be a member of the
family of the original beneficiary. |
Eligible expenses and institutions: Funds in the
529 Plan may be applied to the costs of tuition, fees, books,
supplies, and equipment required for attendance at an "eligible
educational institution." Most accredited institutions of higher
education in the US and some foreign institutions would qualify
as "eligible." This includes most private colleges, public
universities, graduate schools, two-year community colleges, and
vocational-technical schools. Only post high school educational
expenses are eligible expenses. |
The 529 Plan offers many tax advantages.
- Tax-deferred growth -
Earnings on contributions grow free of federal income tax.
Most states also provide tax-free growth for both in-state
and out-of-state plans. Some states also allow a state
income tax deduction for residents who elect to contribute
to their "home-state plan."
- Tax-free withdrawal -
All withdrawals for qualified education expenses - tuition,
fees, books, supplies, on and off-camp[us room and board,
and certain expenses for special needs students - are free
from federal income tax. The provision allowing for federal
income tax-free withdrawals for qualified expenses will
expire on 12/31/2010 unless extended by Congress. (See FAQ-
Tax for more information.)
- Gift Tax benefits
– Anyone can make contributions up to $55,000 per
beneficiary (or $110,000 as a couple) to a 529 account in
one year without incurring a federal gift tax or generation
skipping tax. This is accomplished by “accelerating” five
years of gifting into one year. The special five-year
acceleration provision is only afforded to 529 plans. Any
person can make gifts to an unlimited number of
individuals. Grandparents, for example, could make lump sum
gifts of $55,000 to all of their grandchildren in a single
year without gift tax consequences. The annual gift tax
exemption is increased to $12,000 in 2006 thus moving the
contribution limit up to $60,000 (5 years x $12,000) for an
individual or $120,000 for a married couple if filling
jointly.
-
Estate Tax benefits
– Donors making gifts to a 529 account can generally have
the benefit of their contributions, including earnings,
being excluded from the donor's gross estate. An added
benefit is the assets can be removed from one’s estate while
still allowing the donor to be the account owner and retain
significant control of the assets.
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The donor (account owner) maintains control of the account,
similar to the level of control one has over his or her own
personal checking account. Decisions about how and when account
assets are spent rest with the owner. Control remains with the
owner regardless of the age of the beneficiary. (529 custodial
accounts titled for the benefit of a minor will come under the
minor’s control as defined by state law.) The account owner may
change the beneficiary, providing the new beneficiary is a
member of the family of the original beneficiary. If the
designated beneficiary receives a scholarship, dies or becomes
disabled, there is no penalty for withdrawal of funds.
Investment flexibility allows a full or partial rollover to
another plan, or a change to other investment options in the
same plan, once every 12 months with no federal tax penalties.
A wide range of professionally managed investment options is
available among the various plans. There are no upper age or
income qualifications on who can own an account. |
Withdrawals are limited to being
used for post-high school expenses. Only cash contributions are
accepted; non-cash assets cannot be transferred into a 529
account. Investment options are limited to the specific
investments offered within each individual plan. The sponsoring
state agency has full and exclusive authority to change the
program manager and/or the underlying investment offerings.
Such changes take place without the consent of an account owner
and in some cases limited advanced notice of forthcoming changes
is provided. Comparing features, fees, expenses, benefits, and
investment performance among plans is not easily done.
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Contact a Bannon,
Ohanesian & Lecours Representative for more information.
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