Consider the 529 college savings plan, an increasingly popular way —to save for higher-education expenses, which have more than tripled over the past two decades—with annual costs (for tuition, fees, room and board) of more than $38,000 per year for the average private four-year college.* Named after the section of the tax code that authorized them, 529 plans (also known as qualified tuition plans) are now offered in almost every state.
The newer variety of 529 is the savings plan. It’s similar to an investment account, but the funds accumulate tax deferred. Withdrawals from state-sponsored 529 plans are free of federal income tax as long as they are used for qualified college expenses. Many states also exempt withdrawals from state income tax for qualified higher education expenses.
Unlike the case with prepaid tuition plans, contributions to 529 plans can be used for all qualified higher-education expenses (tuition, fees, books, equipment and supplies, room and board), and the funds usually can be used at all accredited post-secondary schools in the United States.
In most cases, 529 savings plans place investment dollars in a mix of funds based on the age of the beneficiary, with account allocations becoming more conservative as the time for college draws closer. But recently, more states have contracted professional money managers—many well-known investment firms—to actively manage and market their plans, so a growing number of investors can customize their asset allocations.
Some states enable account owners to qualify for a deduction on their state tax returns or receive a small match on the money invested. Earnings from 529 plans are not taxed when used to pay for eligible college expenses.
Funds contributed to a 529 plan are considered to be gifts to the beneficiary, so anyone—even non-relatives—can contribute up to $14,000 per year (in 2013) per beneficiary without incurring gift tax consequences. Contributions can be made in one lump sum or in monthly installments. And assets contributed to a 529 plan are not considered part of the account owner’s estate, therefore avoiding estate taxes upon the owner’s death.
These savings plans generally allow people of any income level to contribute, and there are no age limits for the student. The account owner can maintain control of the account until funds are withdrawn—and, if desired, can even change the beneficiary as long as the new beneficiary is in the immediate family of the original beneficiary.
Benefits for Grandparents
The 529 plan could be a great way for grandparents to shelter inheritance money from estate taxes and contribute substantial amounts to a student’s college fund. At the same time, grandparents also control the assets and can retain the power to control withdrawals from the account.
By accelerating use of the annual gift tax exclusion, a grandparent—as well as anyone, for that matter—could elect to use five years’ worth of annual exclusions by making a single contribution of as much as $70,000 per beneficiary in 2013 (or a couple could contribute $140,000 in 2013), as long as no other contributions are made for that beneficiary for five years. If the account owner dies, the 529 plan balance is not considered part of his or her estate for tax purposes.
Before investing in a 529 savings plan please contact your financial professional.
*Source: The College Board, 2011