The Ins and Outs of 529 Plans
Whether your children are toddlers or teenagers, 529 college savings
plans are an option worth investigating, according to the Iowa Society of
Certified Public Accountants. All states offer some form of 529 plan, an
investment that makes it possible to set aside money for college that will
grow tax deferred while in the plan but is also tax free when withdrawn to
pay for qualified education expenses. Parents, grandparents, or family
friends–anyone, in fact–can set up a 529 plan.
529 Plans Defined
529 plans allow families to save money for college without paying tax on
their distributions. If, for example, in 2007 you make a $10,000
distribution from the plan, it is excludable from income to the extent used
for qualified educational expenses. This means that taxes on earnings within
the plan are not only tax-deferred while in the plan, but also are tax free
when withdrawn.
How They Work
All of the states and the District of Columbia offer 529 plans. Many people
mistakenly believe they can only be used to pay for colleges in the plan’s
home state or for a specific state university. In fact, there are no such
restrictions for 529 savings plans. You can use all the money in your
account at any eligible institution. Another 529 option, a prepaid tuition
contract, makes it possible to lock in the current tuition at a specific
public university (and some private colleges). You can also use your prepaid
tuition contract funds at other schools, but some restrictions may apply.
Evaluate Your Options
With most 529 plans, you can select stock or bond funds offered by
investment companies that are chosen by each state. Contributions can be
made by parents as well as grandparents or other relatives or family
friends. If the account is opened by someone other than the student, the
money is not considered the student’s asset. That’s an advantage if the
student applies for federal financial aid, because the fewer assets the
student has, the more aid he or she is likely to receive.
You can invest in any state’s plan, but you may miss out on state tax
advantages if you pick a plan outside your state. At the same time, each
state plan’s performance will differ, so an out-of-state choice may be a
better investment. It can be tough to compare your choices, because all of
the states’ plans have different investment options and fees. Your CPA can
help you pick the best one.
A Few Caveats
What happens if your child does not go to college? There is a 10% penalty on
earnings that are withdrawn from a 529 plan but not spent on qualified
expenses. The amount you withdraw is also subject to federal and possible
state income taxes. The penalty is not applied to withdrawals of your
original deposits, but only to any interest or income earned on that amount.
The penalty also doesn’t apply if the intended beneficiary receives a
scholarship and the withdrawal is not more than the amount of the
scholarship, or if the beneficiary dies or is disabled. Finally, you can
change the beneficiary to any other qualifying family member. If one child
decides to postpone college, you can transfer the account to another child,
for example.
Of course, while plan fees may have fallen, you should investigate
administrative and other expenses when choosing a 529 plan, as you would
with any investment.
Know Your Options
529 plans are a good vehicle for college savings, but they aren’t the only
one. Other tax-advantaged choices include Coverdell accounts and custodial
accounts for minor children (also know as UGMA and UTMA accounts). Your CPA
can explain each one to you and help you decide which is right for your
situation.
Access “Find a CPA.”
