Section 529 Plans: A Smart Way to Save for College


Section 529 plans are a very user- and taxfriendly way of saving for college for a child or grandchild. The beauty of 529 plans is that they allow for the money invested to grow free of any taxes on income or capital appreciation. These dollars can then be used to pay for the costs of education without being subject to federal income tax when they are withdrawn. Maryland donors also enjoy state income tax deductions for funds contributed to Maryland 529 plans.

Transfers to a 529 plan are made free of gift tax if the transfers are under the $12,000 (or $24,000 for married couples) per donee annual gift tax exclusion. Contributions to the plans can be "gift tax forwarded" for five years, which means that a donor can give up to $60,000 in one year with no gift tax implications. Transfers to these plans also have estate tax benefits because the property contributed (and future appreciation) is removed from the donor's taxable estate.2 For example, a grandparent with a taxable estate could contribute up to $60,000 to as many of his grandchildren's 529 plans as he would like. That means a grandparent with five grandchildren could get $300,000 out of his estate without paying gift tax and save as much as $105,000 in federal estate taxes.

Another tax benefit is a hedge against the recent increase in the "kiddie tax," which now applies to all children under the age of 19 and full-time college students under the age of 24 who do not earn more than half of their income. If children under the age of 19 or full-time students under the age of 24 have an unearned income of over $1,700 per year, that income will be taxed at the parent's marginal rate, which could be as high as 35%. That means that if a college fund is established for a child in the child's name, the income earned on the investments in the account will be subject to the parents' tax rate. Conversely, if the funds are deposited into a 529 plan, there is no tax at all on the investment income.

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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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