If you are a parent or grandparent planning to contribute towards the education of a child or grandchild, a qualified state tuition plan is a tool to get the most out of your contributions. All states have established some type of plan of which there are two varieties, the savings plan, and the prepaid tuition plan.
The popular savings plans are tax-sheltered college-financing techniques permitted under Section 529 of the Internal Revenue Code. These plans are accorded favorable income tax treatment: as long as the withdrawals are used for permissible education expenses, the growth will not be subject to income taxes.
Another remarkable feature is the ability to combine five (5) years’ worth of annual exclusion gifts (currently $15,000 for 2021) in one year. This feature enables a parent or grandparent to give the minor an early and significant start toward college tuition payments. Contributions to such accounts must be made in cash. Note that if you choose the option to make five years of annual exclusion gifts in one calendar year, you will not be able to make another contribution to the plan, or make any other annual exclusion gift, to or for such grandchild until an additional four (4) years have passed.
Most states have plans that allow the donor to invest the assets, although the investment choices are limited. The Internal Revenue Service now permits the donor to switch investment strategies up to once a year. The use of such plans is not limited to individuals based on income tax bracket, so anyone can participate.
529 Plans are specifically intended for higher education expenses, and withdrawals may be used for tuition, room and board, textbooks, and certain other expenses. Additionally, up to $10,000 may be used for expenses for kindergarten through 12th grade tuition. It is important to remember that if the withdrawals are not used for these qualified expenses, there will be both income taxes and a penalty to pay. Fortunately, if a beneficiary doesn’t use or need all of the money in the account established for him or her, the account assets can be transferred to another beneficiary, such as a sibling or cousin. The account holder is the one who maintains control of the account, not the student.
Some states simply offer prepaid tuition plans which assume that the tuition will be paid to one of the state’s public universities. The benefit of these plans is you can lock in the tuition rate at the time the payment is made. However, the main disadvantage is that you must be sure that the child will be attending school in the state that sponsors the plan.
To learn more about the plans of any state, contact the website for the National Association of State Treasurers at www.collegesavings.org.
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