Sect. 529 Plans Offer Tax Incentive to Save for Grandkids' Education
Saving for your grandchildren's college expenses just got easier and more tax beneficial, thanks to recent tax law changes that took effect in January. The centerpiece of the new education-tax perks: the Section 529 college savings plan (named after Section 529 of the U.S. tax code).
"The 529 plan is to today's generations what the savings bond was for past generations," says Philip Johnson, a certified financial planner in Clifton Park, N.Y. "It will be the gift that grandparents give."
Not to be confused with Section 529 prepaid tuition programs that allow families to pay for a child's future education at a state school in today's dollars, Sect. 529 savings plans are accounts established by anybody—a grandparent, parent, other relative or even a friend. The investment grows tax-free, and distributions are also tax-free when used to pay for tuition and other education-related expenses—room and board, books, living expenses, etc.—at any accredited college or university.
A Sect. 529 savings plan offers "unsurpassed" tax breaks and also serves as a handy estate-planning tool, notes Joseph Hurley, CEO of Savingforcollege.com and partner with Bonadio & Co., LLP, a CPA firm in Pittsford, N.Y.
And families will need that help. Consider that a four-year, private college education can cost more than $100,000 today. At a 5.5 percent annual inflation rate (tuition costs rise faster than the overall inflation rate), the price would nearly double in 12 years.
With a Sect. 529 savings plan, a grandparent can contribute as much as $11,000 a year ($22,000 for couples) without triggering the federal gift tax.
(To jump-start your grandchild's Sect. 529 savings plan, you can contribute as much as $55,000—or $110,000 for a married couple—at one time, spreading the gift tax exclusion over the next five years. If the contributor dies within that time, the remaining portion goes back to the estate for tax purposes.)
Moreover, you can establish as many accounts as you want. (Note: You can establish one account per child per state, but you receive only one gift tax exemption per child. For example, if you establish accounts in two different states to benefit the same child, the total contributions count toward the gift tax exclusion.)
Sect. 529 savings plans offer flexibility and control. Unlike certain other vehicles—such as Education IRAs (now known as Coverdell education savings accounts) and custodial accounts (created under the Uniform Gifts to Minors Act)—used to pass money to youngsters, you don't give up control of the Sect. 529 savings plan when the child reaches age of majority (age 18 in most states, age 21 in others). You decide when withdrawals are taken and for what purposes. For instance, if your grandchild wins a scholarship or, worse, becomes a delinquent, you can change the beneficiary. You even can reclaim funds, although withdrawals would be subject to income tax, plus a 10 percent penalty.
Congress authorized Sect. 529 savings plans in 1996, but the new tax-free earnings and added flexibility are sure to increase their popularity. These state-sponsored savings plans are available in 40 states, says Hurley, and residents in states without one easily can sign up for plans in other states. (All 50 states, plus D.C., will have Sect. 529 plans in place by the end of 2002, according to the College Savings Plans Network.) Some states don't tax withdrawals, while others do. You now can roll an account over to a better-performing plan in other states once a year, Hurley adds. Typically, $250,000 is the maximum lifetime contribution for Sect. 529 savings plans, but some states allow higher amounts.
However, keep these cautionary notes in mind:
- A setting sun on the plans' tax-free benefits after 2010. Under current law, the tax-free provision of Sect. 529 plans will be repealed automatically at the end of 2010 unless Congress renews or extends the law. Most observers expect Congress to reauthorize the continued tax-free treatment. Even if Congress doesn't, Hurley urges calm: Most students fall in a lower tax bracket and can claim the Hope or Lifetime Learning credits to help offset the tax hit.
- A possible impact on the student's financial aid options. When grandparents set up a plan, the funds do not initially affect a student's qualification for financial aid, but they can in school years after account funds are withdrawn. Sect. 529 savings plans have more of a direct impact on financial aid when parents or the students themselves establish the accounts.
- Less control over your investment options. With Sect. 529 savings plans, you're essentially putting money into a mutual fund. Although you have choices of investing in aggressive or conservative funds, you can't choose individual stocks. Moreover, many funds have lost money over the last couple of years as the bullish stock market has turned bearish.
