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Nitty-gritty Answers to 529 Plan Questions

Find out what a 529 is, how it's different than other savings vehicles, tax advantages, and information about contributions.

September 18, 2003
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What is a 529 College Savings Plan?
    Named after Section 529 of the Internal Revenue Code, this state-sponsoredcollege savings program allows individuals to accumulate tax-advantaged fundsfor financing college expenses for a beneficiary.

Is it a new plan?
    No, the 529 College Savings Plan is not a new plan. However, the EconomicGrowth and Tax Relief Reconciliation Act of 2001 helped make 529 College SavingsPlans more attractive by allowing distributions for qualified higher-educationexpenses to be exempt from federal taxes.

How does the 529 College Savings Plan affect financial-aid considerations?
    Unlike gifting accounts such as UGMA/UTMAs and Coverdell Education Savings Accounts (formerly EducationIRAs), 529 College Savings Plan assets are currently attributed to the accountowner, not the student, thereby usually lowering the impact on financial aid.Keep in mind, however, that this could change, given ever-changing financial-aidrules.

What does the 529 College Savings Plan offer that other college savings options don’t? 
    In general, the 529 College Savings Plan offers tax-deferred growth, tax-freequalified distributions, higher contribution limits, no income or agerestrictions, and greater control for the account owner.

Is a 529 College Savings Plan the same as a prepaid tuition plan?
    No. Although both are state-sponsored programs and fall under Section 529 ofthe Internal Revenue Code, they are not the same. With a prepaid tuition plan,you prepay tuition at today’s rates for a beneficiary to attend college at afuture date. This involves pre-selecting a participating school, which isgenerally a public school. With the 529 College Savings Plan, you have theflexibility to use funds at just about any college in the United States as wellas some abroad. Additionally, you can build assets tax-deferred.

USE OF FUNDS

What can funds be used for?
    You can use 529 College Savings Plan assets to pay for qualified educationexpenses at almost any college or any post-secondary program in the UnitedStates or in select foreign countries.

What education expenses qualify?
    Qualified expenses include tuition, room and board, books, fees, supplies,and equipment such as a computer.

Can funds be used for private elementary or high-school tuition?
    No, the 529 College Savings Plan is limited to undergraduate and graduatetuition and expenses only.

MAKING CONTRIBUTIONS

Who can set up a 529 plan?
    Parents, grandparents, other family members, friends—anyone can establish a529 College Savings Plan. You can even establish a plan for yourself. There areno age or income restrictions.

What is the maximum amount I can contribute?
    Maximum contributions vary by plan. The highest maximum available todayallows you to invest a lump sum of up to $300,000 per beneficiary. In doing so,however, only $55,000 may be used to satisfy your federal gift-tax exclusion inany five-year period.

Can I continue to contribute to a Coverdell Education Savings Account if I’menrolled in a 529 College Savings Plan?
    Yes, you may. In fact, you may use the money in a Coverdell Education SavingsAccount to pay for K-12 expenses.

Can I make automatic contributions?
    Yes, you can arrange to have funds automatically deducted from a checking orsavings account.

Can I roll over or transfer an Educational IRA, UGMA/UTMA, or existing 529College Savings Plan?
    You may roll over or transfer assets from any gifting or qualified savingsplan to a 529 College Savings Plan.

TAX ADVANTAGES

What are the tax benefits of 529 College Savings Plans?
    There are a number of tax benefits associated with a 529 College SavingsPlan. Your contributions and earnings grow tax-deferred, and you don’t have topay federal taxes when funds are withdrawn to pay for qualified expenses.Exemption on earnings from state taxes is determined by the individual state.Plus, in most cases, both your contributions and earnings are not consideredpart of your taxable estate.

Are contributions tax deductible?
    No, contributions are not deductible from federal taxes. For state taxpurposes, each state makes its own determination.

What does tax-deferred growth mean?
    When you invest in a 529 College Savings Plan, your earnings will not beassessed federal or state taxes, allowing your assets to accumulate withoutpaying taxes on capital gains, dividends, or interest.

Do I have to pay gift taxes on contributions?
    The IRS grants each person an $11,000 annual gift-tax exclusion. In addition,529 College Savings Plans allow you to accelerate the use of this so that youmay contribute $55,000 immediately and avoid gift taxes by using up the nextfive years of gift-tax exclusions.

What are the estate-tax benefits of the 529 College Savings Plan?
    The plan’s high contribution limit means that a contributor can give away asubstantial sum of money in a single year. Couples filing jointly can make agift of up to $110,000 per beneficiary.. Giving away large sums as gifts caneffectively lower the value of one’s taxable estate upon death.

CONTROL

Who maintains control of the account—the student or me?
    Unlike other college savings plans, a 529 College Savings Plan allows you,not the beneficiary, to maintain control of the plan.

Can I change beneficiaries?
    Yes, you have the flexibility to do so at any time.

Can I be a beneficiary?
    Yes, if you are planning on continuing your education in an undergraduate orgraduate program, you can list yourself as a beneficiary.

What if the beneficiary does not attend college?
    You have three options: 1) leave the money in the account in case thebeneficiary changes his mind; 2) change the beneficiary; or 3) make anon-qualified withdrawal (which would be subject to a 10 percent federal penaltyon earnings plus any applicable taxes).

INVESTMENTS

What are my investment options?
    Most 529 College Savings Plans are invested in a portfolio of publicly tradedmutual funds or similar investment vehicles.

Are my plan assets FDIC or DIF insured?
    No, because your assets are invested in mutual funds, they are not protectedby FDIC or DIF insurance and can decline in value.

Can I change the investment options for the assets in my account?
    Each time you contribute to your account, you can elect how each contributionshould be allocated among the investment options. However, you may reallocatethe assets in your account to one or more alternative investment option(s) onlyonce every calendar year or whenever you change the account’s beneficiary.

How much must I invest to start?
    Depending on the plan that best suits your needs, you may be able to getstarted with as little as $15 and continue to invest periodically. You can alsoinvest a lump sum if you prefer.

    Please review the prospectus for each plan carefully before making anyinvestment decisions. Market fluctuation can result in the loss of principal.

    According to the Tax Relief Act of 2001, beginning on January 1, 2002,withdrawals for qualified higher-education expenses are free from federal incometax. State income taxes may continue to apply. The provisions exempting earningson qualified withdrawals from federal income tax expire on Dec. 31 2010,requiring the government to take some further action in order for theseprovisions to remain in effect after Dec. 31, 2010. For more information on taxconsequences, consult your tax adviser.

Workforce, September 2002, pp. 52-55 -- Subscribe Now!

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