Money Management - May 2002

Saving for College

Section 529 Plans Offer Advantages

One of the best college savings plans gets even better this year. As a result of a provision in the Tax Act of 2001, qualified withdrawals from Section 529 college savings plans are now completely tax-free. That factor plus several other significant advantages add to the appeal of this college savings instrument. Section 529 of the tax code gives taxpayers some tax-advantaged ways to sock money away for college: a prepaid tuition plan and a college savings plan. The prepaid tuition plan allows families to lock in today’s tuition costs at state colleges and universities by either paying a lump sum or setting up a monthly payment program. (The new tax law opens the door for private colleges to offer prepaid tuition programs as well, but those distributions will not be tax-free until 2004.) Section 529 plans allow you to make contributions to a state-sponsored savings account and take advantage of the following benefits.

Although many other college savings alternatives limit the amount you can contribute each year or carry parental income limitations, everyone can take advantage of Section 529 plans regardless of income. Depending on the state plan you select, a special provision in the Section 529 law allows you to contribute up to $50,000 in one year and have the gift treated as five gifts of $10,000 each over the next five years. If you are married, you and your spouse can make a combined one-time gift of $100,000.

The assets in a Section 529 plan can be easily transferred between family members. If the intended beneficiary chooses not to go to college, the account owner can designate someone else as the new recipient — another child, grandchild, niece, nephew or, as a result of the 2001 Tax Act, cousin. The money invested in a state-sponsored plan can be used to pay college expenses at any accredited college in the country. Residency requirements don’t exist, so if you don’t like the plan your state offers, you can choose another state’s plan. And because there’s no time limit attached, it won’t pose a problem if the beneficiary decides to take a few years off before entering college.

There is no up-front deduction for contributions to a Section 529 plan, but your investment grows tax-free, and qualified withdrawals are entirely exempt from federal taxes. Some state plans offer in-state residents additional benefits, such as a state tax deduction for contributions up to a certain amount.

If you save for your child’s education under the Uniform Gifts to Minor Act (UGMA), you lose control of the funds in the account when your child reaches the age of majority, 18 years in most states. With a Section 529 plan, the giver retains control until the assets are distributed to pay qualified college expenses.

In terms of determining financial aid eligibility, funds held in a Section 529 plan are treated as an asset of the parent (or whoever opened the account), meaning only 5.6 percent of the money invested in the plan is considered available to cover college costs. By contrast, assets held in the student’s name or in a UGMA account are treated as 35 percent available.

Although the advantages of Section 529 plans are many, CPAs point out that if you make a non-qualified withdrawal from a Section 529 plan, you’ll owe a 10 percent penalty on the amount as well as federal and state taxes on the earnings.

Information on the specific provisions of Nevada’s prepaid tuition program may be found on the state treasurer’s Web site, http://nevadatreasurer.com.