A Flexible Tool For Educational Savings:529 College Savings Plans

We thought we'd turn our attention in this issue of our newsletter to a positive tool that you can use to set aside funds for college education.

  • 529 Plans: How they work. "529 College Savings Plans" (referring to the Internal Revenue Code section under which they are created) are offered by private financial institutions, e.g. major brokerage firms, but are subject to rules and investment standards administered by the various states.

    Under these plans, you can set aside funds for a beneficiary of your choice and the investments grow tax-free. Distributions from the plans are also free from income taxes. Unlike contributions to IRA accounts, though, the contributions to the plans are not deductible, i.e., they're paid from after-tax dollars.

    You can maintain control of the distributions and the account--within the guidelines established by the particular plan established by the governing state-- provided they are used to pay for the college expenses of the beneficiary of the account. If you wish, however, after the plan's inception, you can roll the funds over into a 529 plan account for another beneficiary who is related to the original beneficiary (as defined under the plan), e.g., the beneficiary's sibling or child. As such, if you have one child or grandchild who isn't using his 529 plan investments for college expenses, but has a brother or sister who could use the support, you can switch the funds to a 529 plan for the new beneficiary.

  • Estate and gift tax advantages. Aside from the income tax benefits, 529 plans also offer gift and estate tax advantages. Usually you can only transfer $11,000 per recipient per year--$22,000 if you are a couple making the gift--without potential gift tax implications. With 529 plan contributions, however, the IRS lets you use five years' worth of such exempt gifts in one year, although during such five year period, no further nontaxable gifts can be made.

    The amounts set aside in 529 plans are also excluded from your estate for estate tax purposes. Accordingly, these plans can be a good vehicle for reducing the size of your estate and potential estate taxes.

  • Limits on contributions. There are limits that vary from state plan to state plan on the total amount that can be placed in a 529 plan per beneficiary. For most states, the limit is $200,000. For Colorado plans, for example, the amount is $235,000. You don't have to live in Colorado by the way, to fall under Colorado's plan rules. If the brokerage firm you have chosen has adopted a particular state's plan, for example, then those are the rules that apply.

  • Comparison to other techniques. These plans differ from Uniform Transfer to Minors Accounts in that there is no age at which they must be distributed to the beneficiary. Moreover, the beneficiary can in effect be changed within the guidelines mentioned above. Furthermore, 529 plan funds are limited to college expenses, whereas Uniform Transfer to Minors accounts can be used for health and support, as well as education in general.

    In addition to the college savings plans discussed above, Section 529 also enables states to set up prepaid college tuition plans. These plans allow you to prepay tuition with a particular state that locks in current tuition prices. For example, you would pay for two years' tuition at today's rate, which would be good in the future even though tuition has increased by the time the beneficiary attends college. These usually apply to public colleges in the state that is sponsoring the plan.

    Another option is to pay academic tuition directly to the educational institution on behalf of the beneficiary of your choice. These payments do not incur a gift tax regardless of the size of the contribution and do not affect your annual nontaxable gifts.

    There are various websites that discuss 529 plans. One good site is www.collegesavings.org.

    You should consult with your financial counselor in determining whether and which investment devices are best suited to your financial needs. We would be glad to explain how these plans coordinate with your estate and gift tax planning, however, and to discuss your estate planning needs in general. Members of our Trusts & Estates Group include Julie Dickens, Alan Macpherson, Sue E. O'Reilly, Eileen Peterson and Sandy Rovai.