08/ 05/ 2002
by Phillip L. Pennartz
A state-sponsored college savings program called the "529 Plan" lets you invest in mutual funds for your child's or grandchild's education with tax-free earnings, and lets you make tax-free withdrawals that can be used at any college, in-state or out.
Under a 529 Plan you can:
1. Make tax-free withdrawals for qualified expenses at any accredited college;
2. Reduce your taxable estate by as much as $55,000 in the first year; and
3. Retain control of that money, even if you move out of state.
Until this year, earnings in a 529 Plan would grow tax-deferred until you made qualified withdrawals. Then you would pay federal income tax on the growth at the beneficiary's rate (usually 15 percent). But now, due to the Tax Relief Act of 2001, which went into effect January 2002, 529 Plans are more attractive for college savers.
Consider what 529 Plans offer:
- Tax-free earnings.
- Tax-free withdrawals. You used to have to pay taxes on growth for qualified withdrawals, but now you don't on distributions for qualified education expenses, which include tuition, room and board, books, supplies, and equipment.
- No income limitations. Unlike the Coverdell IRA, which excludes people with incomes above $220,000, 529 Plans are open to everyone regardless of income.
- Donor-controlled disbursements. If plans change and your child earns a full scholarship or decides not to go to college, you can designate another beneficiary.
- Estate planning benefits. When contributing to a 529 Plan, you can move significant assets out of your estate and still retain control of disbursements.
- High contribution limits. The maximum contribution varies from state to state, with the current cap at $265,000. One investor can contribute more than that limit by opening multiple accounts for different beneficiaries.
The limitations: You can only make withdrawals for qualified education expenses. Otherwise, you must pay a 10 percent penalty against the account's earnings, in addition to taxes on the earnings at your income tax rate.
Finding the Right Plan
Start at www.savingforcollege.com for the low-down on each state's 529 Plan. Also consult your financial advisor for more information about your specific situation.
Here's what to look for:
- Potential tax credit. Some states let you deduct 529 contributions against state tax.
- Investment options. Some states have all stock plans, or all fixed-income plans, or blended plans that change over time. What you pick depends on the beneficiary's age and your risk tolerance. Many state programs are open to non-residents.
- Minimum/ maximum contribution limits. This varies by state and administrator. Some companies let you open an account for as little as $25. But if you contribute just a little, make sure annual fees don't eat it up.
Pennartz is a registered principal with IFG Network Securities Inc., in Norcross, Ga. You can reach him at 770.642.0084 or by email at ppennartz@mindspring.com.
This article originally appeared in the August/September 2002 issue of MyBusiness magazine.
