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Sec
529 Plan
The
primary focus of this article is on the option to save for future
college costs by using qualified state tuition programs established
under Section 529 of the Internal Revenue Code. The reason for focusing
on 529 plans is that they provide some powerful and unique tax advantages
not available with the other options you have in saving for college.
What other tax-advantaged program allows everyone to participate,
without regard for age or income level? What other program allows
the accumulation of over one hundred thousand dollars in a tax-sheltered
account for one child's future college costs? What other mechanism
allows someone with a large estate to immediately reduce that estate
by $50,000 per child (or grandchild) without triggering gift tax,
and without losing control of the assets?
The answer is that there is no other tax-advantaged program that
provides the combination of benefits that a 529 plan does. It is
a unique and wonderful creation that comes in as many different
forms as the number of states that sponsor them. It is intended
to serve one purpose-providing a way for families of any income
level to save for future college costs in the most effective way
possible. But in so doing, the 529 plan actually has investment,
tax, retirement, and estate planning implications that reach far
beyond this one purpose.
The 529 plan is, simply stated, probably the best place to save
significant amounts of money for families with school-age children
or grandchildren. Section 529 plans are designed with many features
and tax incentives to overcome the reluctance on the part of families
to save for future college expenses. No matter what circumstances
a family may be in-large or small, low-income or high-income, decided
on a particular college or undecided, transient or settled-there
are programs available to accommodate college saving desires in
simple, flexible, and tax-efficient ways. In fact, the tax advantages
of a 529 plan can be used even if there are no school-age children
or grandchildren. Who's to say that the older individual will not
want to return to school at some point in the future?
Before going any further, we turn our attention to one of the most
significant concerns that many parents will face in their consideration
of 529 plans. This concern relates to the financial aid process
and the impact of an interest in a 529 plan on financial aid awards.
In short, saving for college with a 529 plan will impact a student's
financial aid eligibility, although the precise effect will depend
on the type of 529 plan and the policies of the institution. Of
course, saving for college through other means can have a negative
impact as well, in many cases worse than a 529 plan.
It may actually make sense to increase a college savings fund by
borrowing money and contributing this money to a 529 plan. The reason
for this is that the interest paid on the debt may produce an income
tax deduction to the donor at a high tax bracket, while the earnings
will not be taxed until the future, and then only at the student's
lower tax bracket.
The estate and gift tax rules surrounding 529 plans are unique and
the planning considerations are anything but straightforward. The
gift tax provisions contained in Section 529 create a result that
flies in the face of the general gift tax rules contained elsewhere
in the Internal Revenue Code. Consider the couple with large taxable
estates who have four children to someday inherit the remnants of
their estates (after estate taxes). With each parent contributing
$50,000 to the 529 plan account of each child, this couple can effectively
remove $400,000 from their combined estates in one day without using
up a single dollar of their lifetime exemptions. Not only is the
value removed from their taxable estates, but it is invested in
a fund that should appreciate nicely over time without the drag
of income taxes (because earnings are tax-deferred). And so the
estate tax savings will grow even more substantially. That's effective
estate planning!
Certainly, a large proportion of 529 plan accounts will lead very
ordinary lives. A parent will set up and fund an account or contract
for a son or daughter in their state's program, and that child will
end up using the entire value of the account to pay for qualified
higher education expenses in the future. For some people, that will
work very nicely, and even the most inflexible state program (including
many of the prepaid tuition plans) could be an appropriate choice.
An increasing number of people, however, will seek to take advantage
of the flexibility offered by many of the newer 529 plans, primarily
of the savings variety. A donor will fund (or "bait") an account,
and in the future "switch" some aspect of the account. Well-timed
switches can save federal and state income taxes, estate taxes,
and generation-skipping transfer taxes, as well as enhance eligibility
for federal financial aid.
Be sure to consult with a tax advisor for proper planning and implementation
of tax savings ideas to be sure they are right for you.
C.
David Pitzer, CPA, PC
118
Two Mile Pike
Goodlettsville, TN 37072
(615) 851-2727
Fax: (615) 851-8711
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