Close-Up: 529 Savings Plans

n

529 Savings Plan: . A state-operated investment plan that gives families a federal tax-free way to save money for college.

In 1996, as part of the Small Business Job Protection Act,Congress passed legislation authorizing qualifiedtuition programs. As part of the legislation, Section 529was added to the Internal Revenue Code to providethese programs with special tax breaks. The programs,which have become one of the more popular options forfamilies saving for a child's college education, becameknown as 529 savings plans.

The BestWay to Save for College

According to Joseph Hurley, CPA, author of ($26.95; BonaCom Publications;2002), section 529 plans are designed with many featuresand tax incentives. No matter what a family's circumstancesare—large or small, low or high income, decidedor undecided on a particular college—there are programsavailable to accommodate college saving desires.However, despite the availability and tax-efficient featuresof 529 plans, they remain a mystery to some familiesand a neglected savings vehicle to others.

529 SAVINGS PLAN FACTS

Nearly every state has a 529 savings plan in place, andwhile each plan has its own set of rules and restrictions,they all share some common elements. For example,earnings from a 529 plan are exempt from federal taxes,as are any withdrawals, provided they're used towardthe cost of college. As an added benefit, some states alsowaive state taxes for residents, while others allow deductionson contributions. And most states hire experiencedinvestment companies, like TIAA-CREF, to manage their529 accounts.

Most 529 plans have generous maximum contributionlimits, some as high as $250,000 per beneficiary. They'realso great estate planning tools for grandparentsbecause contributions made to the plan are consideredcompleted gifts and are therefore excluded from theirestate. Grandparents can also switch beneficiaries toother grandchildren, and parents can change the beneficiary to a first cousin. Even if there are no children orgrandchildren in the equation, an older family membermight want to return to school at some point (eg, duringa change of career) and the funds in a 529 plan can beused for that individual's education.

Flexibility truly is key when it comes to 529 savingsplans. For example, investing in your state's 529 plandoesn't preclude you from using the savings at collegesand universities outside your home state. If you're not tookeen on your own state's plan, consider those of otherstates. Most impose no residency restrictions. If you'reunhappy with the performance of your investmentoptions, you can changethem within the sameplan once per year. Andif you become dissatisfied with your currentplan, you can roll itover into another 529plan once per year.

TWO TYPES OF PLANS

Be aware:

There are basically 2 types of 529 plans: college savingsplans and prepaid tuition plans. According to theCollege Board (www.collegeboard.com), college savingsplans allow parents to use plan funds for collegeexpenses at any college. Prepaid tuition plans, alsoreferred to as Prepaid Education Arrangements, enableparents to lock-in future in-state public college tuitionat present prices. Each plan has its share ofadvantages and disadvantages.

College savings plans, also known as EducationSavings Accounts, are state-managed investmentaccounts that have no residency restrictions. The fundscan be used at most accredited public or private collegesor universities and contributions of up to $11,000annually can be made without triggering any gift tax.However, these plans are not guaranteed to make aprofit, they have a relatively short track record, andaccount manager fees can be as high as 2% of annualearnings. States are also not required to share theirperformance with investors on a regular basis.

Prepaid tuition plans, on the other hand, are guaranteedby state governments to at least match in-state collegetuition increases. They are a low-risk option thatusually outperforms savings accounts or CDs. However,participation is often restricted to state residents. Withsome plans, funds can only be used to cover tuition andfees, not room and board. Investments are also conservative.So, if your child won't be attending college foranother 5 years, you may want to consider a moreaggressive option.

529 Plan Checklist

The Best Way toSave for College

If you're thinking about investing in a 529 savingsplan, a little homework upfront is necessary. A goodprimer can be found in the book, by Joseph Hurley, CPA. He also hasan informative Web site (www.savingforcollege.com), with links to all state 529 plans. Beyond that,you'll want to request a packet of program materialsfrom your own state as well as from other stateswhose plans you are considering. The informationpacket is free, and should, at the very least, containthe following items:

• A copy of the state statute that is authorizingthe program.
• A description of the program, which will alsoexplain the tax treatment attributes of 529 investmentplan accounts.
• A listing of all the rules of the program. Theseare prone to frequent change, so be certain whatyou receive is the most current version.
• Investment prospectuses for the mutual fundsused by the plan.
• A program booklet containing an enrollment/application form, as well as answers to frequentlyasked questions.
• The plan’s Web site address. Every 529 plan hasa Web site where you can download all the materialsin the enrollment packet, link to other informationsites, and calculate the cost of college.

CME Quiz

1) 529 savings plans are also known as:

1. The College Fund
2. Qualified tuition programs
3. Flexible savings plans
4. A great deal

2) Earnings from a 529 plan are exempt from:

1. Federal taxes
2. Local taxes
3. Unemployment taxes
4. Real estate taxes

3) You can roll one 529 plan into another:

1. Once per quarter
2. Once per year
3. Every 6 months
4. Whenever you like

4) Prepaid tuition plans:

1. Are not guaranteed to make a profit
2. Can be used at most colleges
3. Guarantee to match in-state college tuitionincreases
4. Carry high account manager fees

5) Which of the following should be in a 529-plan information packet?

1. State statute
2. Program description
3. Investment prospectuses
4. All of the above

Answers: 1) b; 2) a; 3) b; 4) c; 5) d.