Planning For College - 529 Accounts


[author: David M. Watts, Jr.]

If you have a child (or a grandchild) who is going to attend college in the future, you have probably heard about qualified tuition programs, also known as 529 plans (for the Internal Revenue Code section that provides for them), which allow prepayment of higher education costs on a tax-favored basis.

There are two types of programs: prepaid plans, which allow you to buy tuition credits or certificates at present tuition rates, even though the beneficiary (your child or grandchild) won’t be starting college for some time; and savings plans, which depend on the investment performance of the fund(s) you place your contributions in.  The tuition credits increase in value as the cost of tuition goes up at your beneficiary’s selected college, which does not have to be determined until payment is to be made.

You don’t get a federal income tax deduction for the contribution, but the earnings on the account aren’t taxed while the funds are in the program. You can change the beneficiary or roll over the funds in the program to another plan for the same or a different beneficiary without income tax consequences.  Pennsylvania allows you to deduct contributions to a 529 account up to $13,000 per year, per beneficiary.

Distributions from the program to pay college expenses are tax-free if they don’t exceed the student’s qualified higher education expenses. These include tuition, fees, books, supplies, and required equipment. Reasonable room and board is also a qualified expense if the student is enrolled at least half-time.

Distributions in excess of qualified expenses are taxed to the beneficiary to the extent that they represent earnings on the account. A 10% penalty of the tax due is also added to the tax bill, but otherwise unused funds can be returned to the account owner.

Eligible schools include colleges, universities, vocational schools, or other postsecondary schools eligible to participate in a student aid program of the Department of Education. This includes nearly all accredited public, nonprofit, and proprietary (for-profit) postsecondary institutions. A school should be able to tell you whether it qualifies.

The contributions you make to the qualified tuition program are treated as gifts to the student, but the contributions qualify for the annual gift tax exclusion, which is $13,000 for 2012. If your contributions in a year exceed the exclusion amount, you can elect to take the contributions into account ratably over a five-year period starting with the year of the contributions. Thus, assuming you make no other gifts to that beneficiary, you could contribute up to $65,000 per beneficiary in 2012 without gift tax consequences. In that case, any additional contributions during the next four years would use up part of your unified credit, except to the extent that the exclusion amount increases. You and your spouse together could contribute $130,000 for 2012 per beneficiary, subject to any contribution limits imposed by the plan.

Pennsylvania offers both a prepaid plan (the Guaranteed Savings Plan) and a savings plan offering Vanguard products.  Most other states offer some type of 529 plan which Pennsylvania residents are free to invest in, and there is a Private College 529 Plan which is not connected to any state but which is a prepaid tuition credit plan guaranteed by the many colleges participating in the plan.

If you would like to further discuss how the qualified tuition program might help to meet your child’s future college costs, please give us a call.

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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