If you have a child (or a grandchild) who you expect will attend college in the future, you should consider making contributions to a 529 Plan for their benefit.
529 Plans have their name because they are authorized by Section 529 of the Internal Revenue Code. There are actually two types of 529 Plans. The first is a Prepaid Educational Services Account which allows for the purchase of tuition credits on behalf of a designated beneficiary. The second is an Education Savings Account which allows for contributions to an investment account established for payment of future higher education expenses of undergraduate and graduate education for the designated beneficiary. The Education Savings Account provides the most flexibility and will be the focus of this article. References herein to a 529 Plan will mean an Education Savings Account.
All contributions to a 529 Plan must generally be made in cash. You cannot contribute stocks or other securities to a 529 Plan. You do not get a federal tax deduction for a contribution to a 529 Plan, but the earnings on the account are not subject to income tax while the funds remain in the 529 Plan. Thus, the 529 Plan assets are allowed to grow tax-free.
You can change the beneficiary or roll over the funds in the 529 Plan to another plan for the same or a different beneficiary, without tax consequences. There are no income limits for the person making contributions to a 529 Plan, therefore, high income taxpayers can also utilize 529 Plans (unlike some other types of programs such as Roth IRAs).
Distributions from the 529 Plan are also tax-free, so long as the distributions are used to pay for the beneficiary’s qualified higher education expenses. “Qualified higher education expenses” include: tuition, fees, books, supplies, and required equipment. Reasonable room and board is also a qualified expense if the beneficiary is enrolled at least as a half-time student.
Distributions in excess of qualified expenses are taxed to the beneficiary to the extent such distributions represent earnings on the account. A 10% penalty tax will also be imposed. However, since you can change the beneficiary of the 529 Plan to any other family member of the beneficiary, you can always change the beneficiary if the account has a balance after the original beneficiary has completed his or her higher education in order to avoid income taxes and penalties.
Any college, university, vocational school, or other postsecondary school eligible to participate in a student aid program of the Department of Education can participate in a 529 Plan, including nearly all accredited public, nonprofit, and proprietary (for-profit) postsecondary institutions.
You may be the owner of a 529 Plan, or any other person or trust you select. You may also designate a successor owner in the event of your death. The 529 Plan owner has certain powers, such as the discretion to make distributions, the power to change beneficiaries, and the power to select investment options. There may also be certain advantages to making a trust you control the owner of a 529 Plan.
The contributions you make to the 529 Plan are treated as gifts to the beneficiary, but the contributions qualify for the annual gift tax exclusion, which is $12,000 for 2007. 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. Thus, assuming you make no other gifts to that beneficiary, you could contribute up to $60,000 for each beneficiary in 2007 without gift tax. You and your spouse together can contribute $120,000 per beneficiary, subject to any contribution limits imposed by the Plan.
All 50 states and the District of Columbia have their own 529 Plans. Generally, you can invest in any one of the plans, although your investment advisor may have a specific recommendation since each state’s plan has its own investment manager and each state’s rules and requirements may differ. Indiana’s 529 Plan allows for maximum contributions up to $298,770 per beneficiary (which could take many years if you contribute $12,000 per year), although you can make contributions as small as $50.00. Indiana’s plan is managed by JP Morgan and can be accessed directly, or through your investment advisor.
If you, or your beneficiary, are Indiana residents, there may be advantages to opening an Indiana 529 Plan. For example, beginning in 2007, you receive a tax credit on your Indiana income tax return equal to 20% of a contribution to an Indiana 529 Plan (e.g., for a $1,000 contribution, you would receive a credit of $200). More information about Indiana’s 529 Plan can be found at http://www.collegechoiceplan.com/.
If you would like to further discuss how a 529 Plan might help you to meet your estate and financial planning goals, please call Burke Costanza & Cuppy LLP (219.769.1313)