Get Educated on Section 529 College Savings Plans
College education costs continue to spiral upward. For many families, Section 529 plans are a sensible and tax savvy way to meet future education expenses. According to the Colorado Society of CPAs, you should be familiar with the two types of Section 529 plans, both of which are sponsored by individual states: prepaid tuition plans and college savings plans.
Prepaid tuition plans are investment accounts that allow families to pay today's prices for a child's future college tuition at an in-state public college. Because these plans substantially restrict school selection, their appeal is limited. College savings plans, the more popular of the two Section 529 plans and the subject of this article, are more flexible.
Section 529 basic skills
A Section 529 college savings plan is an investment account established for funding qualified higher education expenses. The funds can be used for tuition and other costs, such as room and board, books, fees, supplies, and equipment.
Most college savings plans offer an asset allocation strategy based on the child's age. They start off with a more aggressive strategy when the child is younger, and gradually shift to more conservative investments as college nears.
Tax incentives get high marks
The earnings on money invested in a Section 529 college savings plan grow free of federal income tax. Withdrawals are free from federal income tax as well (at least until 2010, unless Congress takes action to extend to the provisions), as long as the proceeds are used to pay for qualified higher education expenses. Most states offer similar tax treatment of earnings and withdrawals.
While Section 529 contributions are not federally tax deductible, some states do permit a full or partial deduction for state income tax purposes.
Open enrollment is available
You can contribute to a Section 529 college savings plan regardless of your annual income or your age. In fact, anyone - relatives, friends, neighbors - can contribute money on behalf of the beneficiary. There are no deadlines - you may enroll whenever you choose.
Investment minimums are low and there is no cap on yearly contribution amounts. Each state determines its own lifetime contribution limit. Most are in excess of $100,000 and some are greater than $200,000.
Investing without boundaries
You are not limited to your state's college savings plan. You have the option of investing in any of the plans of the 50 states. Over 20 states and the District of Columbia offer a deductible contribution on state taxes, so if you live in one of these states, you are wise to invest in its plan. Generally, the tax savings will outweigh other benefits.
In general, look for plans that offer a number of investment options. This will help you to better manage investment risks. Secondly, review the fees and expenses associated with state plans you are considering. High management and maintenance fees can erode your savings. Be aware that in many instances, nonresidents will pay higher fees than residents, making the 529 plans in your own state generally more attractive. The good news is that most plans are "portable" meaning that you can roll your savings into another state's plan without penalty.
In cases where the beneficiary decides not to attend college, the plan owner may change the beneficiary to another family member, without tax consequences. If a new beneficiary is not an option and the account owner closes the plan, he or she is subject to income taxes and a 10 percent penalty on earnings.
For more information on state plans, go to wwww.collegesavings.org or www.savingforcollege.com
The final assessment
It's difficult to find fault with Section 529 college savings plans but there are a few caveats you should be aware of. First, there's no guarantee that Congress will extend beyond 2010 the current tax-free treatment of withdrawals. If this provision is not renewed, the earnings portion of the withdrawal will be taxed at the student's rate.
Second, Section 529 college savings plans are treated as parental assets in financial aid formulas. While this means they have a low impact on financial aid eligibility, it is a factor that warrants consideration.
Finally, unlike IRAs and 401(k) plans, which give you the flexibility to be as aggressive or conservative as you choose, you have no say in how your money is invested in a Section 529 college savings plan.
A CPA can help you determine the role of a Section 529 plan in your overall college savings strategy.