Funding College and Graduate School Using Qualified Education Savings Programs

college fund 529Planning for higher education – whether for your children or grandchildren – may seem like a daunting task.  What many people don’t know is that there are qualified education savings programs, called 529 plans, that are operated by states or educational institutions, which have substantial tax benefits to those contributing.

529 plans area established and run by both educational institutions and nearly all US states.  State plans are available to out-of-state residents and students can use the plans to pay for out-of-state universities.  State sponsored plans permit the contributions to be invested in a variety of ways.

Unlike other types of educational savings accounts (such as Coverdell plans), for 529 plans, there are no income-based limitations on contributions.

Investment options within 529 plans are generally quite flexible.

 

Are 529 Contributions Tax Deductible?

Contributions to 529 plans must be contributed in cash and are treated by the internal revenue code as a completed gift with no strings under the estate and gift tax rules.

529 contributes are not tax deductable on your federal return but they may be deductable on your state return depending on the state in which you live  (check with your tax advisor).

 

How much can I contribute to a 529 plan?

The maximum annual gift that an individual can contribute is $14,000 in 2014

There is, however a special rule that permits an election to spread contributions over 5 years.  If a grandparent wanted to make a gift to a grandchild, she could make a gift up to $70,000 in one year without gift tax consequences (=$14,000*5 years).  In order to make the 5 year election, it is important that the election is made on form 709 by checking the Schedule A box with an attached explanation.  We recommend you consult your financial planner for this paperwork.

A married couple can elect to split gifts, thereby making the maximum contribution $140,000 ($70,000 per person for the 5 year spread) per account in a year.

Is it Subject to Income Tax?

Investments earned on 529 plans are not subject to current income taxes.

Distributions take from 529 accounts are excluded from taxable income when used to pay for qualified higher education expenses.

Qualified expenses are for college or graduate school only (not elementary) for students who are enrolled at least half-time and include:

  • Tuition
  • Fees
  • Books
  • Supplies
  • Equipment (such as computers)
  • Room and board

Unlike other educational savings vehicles, there’s no age limit on taking distributions or when a 529 plan must terminate.

Choosing between a 529 plan and other savings plans

Individuals are allowed to contribute to both 529 plans AND Coverdell savings accounts in the same year for the same student. Beneficiaries can take  distributions from both accounts in the same year (although not for the same expenses).

 

Miscellaneous

Distributions for reasons other than higher education are subject to income tax as well as a 10% penalty.

The donor can change a beneficiary to a different family member without any tax consequences.

If you’re displeased with the performance of your savings account, you can roll over to another 529 plan for the beneficiary within 60 days without income tax issues.  This is only permitted once a year.

 

IRS CIRCULAR 230 NOTICE:  To the extent that this message or any attachment concerns tax matters, it is not intended to be used and cannot be used by a taxpayer for the purpose of avoiding penalties that may be imposed by law.  LEGAL, INVESTMENT AND TAX NOTICE:  This information is not intended to be and should not be treated as legal advice, investment advice or tax advice.  Clients should under no circumstances rely upon this information as a substitute for obtaining specific legal or tax advice from their own professional legal or tax advisors.

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