White Papers - Saving for College With “529” Plans

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As a tax lawyer and advisor, a frequent question that is asked of me is “what is the best way to save for college?” Until two years ago, the best ways were not very efficient. Aside from simply putting money in a bank account or buying stocks in a parent’s name, other strategies involved establishing elaborate trusts, or creating bank or stock accounts that reverted to a child at the age of 21 years, regardless of the child’s capacity for handling such money. Further, these strategies generally required taxes to be paid on the growth of such funds. Beginning in 2001, however, the Congress enhanced an existing provision in the Internal Revenue Code, “the 529 Plan”, to make it an excellent vehicle for saving for college. A 529 Plan draws its name from its Internal Revenue Code designation.

529 Plans have now been adopted and sponsored in almost every state. They take one of two forms, either pre-paid tuition credits or accounts that can be used when a child is ready for college. It is the second type that has become very popular. While state sponsored, accounts need not be established in the state where the person setting up the account (“the account owner”) resides or where the potential college student resides. The account does not have to be established in the state where the student intends to attend college. Each state sets forth its own rules regarding its accounts, limited only by certain requirements set forth Congress. In a 529 Plan:

• The money contributed to the account grows income tax free;
• When the money plus earnings is distributed from the account and used for college, it is not taxed;
• The account owner has the ability to switch accounts to another potential student, and, depending upon the family relationship to the account owner, this can generally be done tax free;
• The account owner can actually take the money plus earnings back if the event that he/she needs it;
• If the money and earnings is not used for college but used for other things, taxes are paid on the earnings and a penalty tax is imposed;
• Although the account owner controls the account during his/her lifetime, generally the amount in the account is not subject to estate taxes if the account owner dies.
• The contribution to a 529 Plan must be made in cash, and is made with after tax dollars (there is no income tax deduction for the contribution). Up to $11,000 per year per account can be made, or $22,000 if a husband and wife make a joint gift. In addition, a contribution can be “prepaid” up to 5 years.

Since most states offer 529 Accounts, it pays to shop around to find the state that best fits an account owner’s needs. Many states have brought in well-known money managers to run their 529 Programs. Generally, an account can be set up with as little as $500, and additions of as little as $100 can be made. If you would like more information on this college saving strategy click here to read the full article in the White Papers.

© 2003, Carlin & Ward, P.C.