529 savings plans
529 savings plans are operated by a state or educational institution designed to help you set aside funds for future college costs. As long as the plan satisfies a few basic requirements, the federal tax law provides special tax benefits to you.
529 savings plans are usually categorized as either prepaid or savings, although some have elements of both. “Under a prepaid plan, you are buying years of college; whereas, with an investment plan, your contributions are invested until they are needed for college,” Ritter says. Every state now has at least one 529 plan available.
Four advantages
There are four main advantages to 529 plans. First, your investment grows tax-deferred, and distributions to pay for your grandchild’s college costs come out federally tax-free. The taxfree treatment was made permanent with the Pension Protection Act of 2006.
Your own state may offer some tax breaks as well, like an upfront deduction for your contributions or income exemption on withdrawals, in addition to the federal treatment.
Second, you stay in control of the account. With few exceptions, your grandchild has no rights to the funds. You are the one who calls the shots; you decide when withdrawals are taken and for what purpose.
Most plans even allow you to reclaim the funds for yourself any time you desire, no questions asked. However, the earnings portion of such a withdrawal will be subject to income tax, plus an additional 10% penalty.
Compare this level of control to a custodial account under the Uniform Gifts to Minors Act. What’s more, if your grandchild receives a substantial scholarship and does not need your help, the funds will be returned to you, after income taxes on the earnings, but without the penalty.
Third, a 529 plan can provide a very easy hands-off way to pay for college. Once you decide which 529 plan to use, you complete a simple enrollment form and make your contribution. Then you can relax and forget about it if you like. The ongoing investment of your account is handled by the plan, not by you.
Plan assets are professionally managed either by the state treasurer’s office or by an outside investment company hired as the program manager.
You won’t even receive a Form 1099 to report taxable or nontaxable earnings until the year you make withdrawals. If you want to move your investment around, most programs permit you to change to a different option in a 529 savings program every year; or, you may rollover your account to a different state’s program.
Finally, everyone is eligible to take advantage of a 529 plan, and the amounts you can put in are substantial. Many states allow contributions of $300,000 or more for each grandchild. And generally, there are no income limitations or age restrictions.
Do it right
So, if you decide to help your grandchildren with their education, make sure you do it properly. Your financial advisor can tell you the best way to help out the most, while substantially reducing your tax bill. You can also visit one of these websites for more information:
www.collegesavings.org
www.sec.gov/investor/pubs/intro529.htm
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