A Flexible Way to Save for Higher Education: 529 Savings Plans
In fact, with the price tag for a four-year degree expected to increase 165 percent for both public and private institutions by 2020, according to a recent study by the College Board, meeting education savings goals can be downright overwhelming.
Section 529 of the Internal Revenue Code allows states to create savings account trusts. And, thanks to 529 savings plans, putting money away for college has become easier.
Residents of any state are free to compare the programs established by other states and invest in the plan that is most appealing to them. In some states, residents receive a state income tax deduction for contributing to the 529 plan offered by their state of residence However, this is not a requirement for investing in a plan.
Established as “ready-made” investment portfolios, 529 savings plans provide an account for a significant amount of money to be saved to cover the ever-rising costs of higher education. Over time, an individual can contribute up to the maximum set by each state’s plan. Currently, the highest maximum is $300,000 and is expected to grow.
In short, the plan allows for flexible college savings by permitting individuals to make larger contributions than what has been allowed in the past, while also providing estate and tax planning benefits.
Two parties are involved in every 529 savings plan account – the donor, or account owner, and the beneficiary, or future college student. Contributions made by the donor are treated as gifts for tax purposes, which means they qualify for the $11,000 annual gift tax exclusion.
Moreover, as long as no additional gifts are made to that beneficiary for a five-year period, the donor can contribute up to $55,000 – or $110,000 per couple – per beneficiary, without federal gift-tax consequences. This means that larger contributions can be invested sooner and will begin growing federal tax-deferred. In addition, the account is not considered part of the account owner’s taxable estate.
Let’s look at one set of grandparents that has a $1,750,000 estate and six grandchildren. Under current estate tax laws, $1,500,000 would be exempt from estate taxes with the remaining $250,000 subject to taxation. With the 529 savings plan as an option, $110,000 could be contributed to a 529 savings plan in a single year for each of the six grandchildren, thus sheltering $660,000 from taxation.
Clearly, there are several advantages for the donor funding this type of account. Yet there are also tremendous benefits for the student entering college.
Let’s consider another example. A mother has set up a 529 savings plan account for her son, Johnny. When the time comes, Johnny can use the account for qualified expenses at any accredited institution of higher education in the United States and at some foreign institutions. This includes colleges, universities and graduate schools, as well as most community colleges, and vocational and technical schools, whether public or private. Qualified expenses include tuition, fees, books, supplies and equipment required for enrollment or attendance. Furthermore, Johnny has the ability to claim tax deductions on his tuition.
As money is taken from the 529 savings plan to pay for qualified expenses, equal portions of principal and earnings are taken federal tax-free.*
In addition, under the provisions of the 529 savings plans, if Johnny quits after a week of school – or if he decides not to attend college at all – his mother would assume complete control of the money. In other words, when Johnny turns the age of majority, he does not have access to the money like he would have had in a UTMA/UGMA account.
Furthermore, Johnny’s mother can change the beneficiary of the account. She can also take the money out of the account, although a 10 percent penalty would apply for doing so and earnings would be taxable.
The 529 savings plan can be a powerful, flexible, tax-free way to save for higher education and shelter hard-earned dollars from estate taxation. To find out more about these plans and how they can help you fund your child or grandchild’s education, contact your financial adviser.
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Daniel Dueweke is a financial adviser with AHP Financial Services (AHPFS), offering financial planning and investment management services. AHP Financial offers securities exclusively through Raymond James Financial Services, member NASD/SIPC. AHPFS is also an affiliate of Andrews Hooper & Pavlik PLC.