I am the mom who is always out of the loop. I listen as parents around me advise that my daughter needs to be involved now in lacrosse so that she’ll have a good chance of getting into an Ivy (but… but… she’s 7); that all of the cool kids are going to science camp; that everyone knows that you have to buy your kids’ uniforms the January before if you stand a chance of having one on the first day of the new school year. I sometimes feel like I’m horribly behind.
But one thing I have managed to figure out – and occasionally fund – are college savings plans. With three kids, it’s more than a little bit more than important that I have a strategy for assisting with college. I’m still paying off loans from my own education and I’d rather not pass that burden to my kids.
As I blogged before, I was initially a little overwhelmed by it all. I thought it would be difficult and expensive to set up and maintain. It’s not. It’s easy. And it has a few notable tax advantages.
First, the basics: A 529 plan is an education savings plan. It takes its name from section 529 of the Internal Revenue Code. The plans are relatively new, having been around only since 1996, and can be found in all fifty states – and the District of Columbia.
Second, the reason they make sense: For federal tax purposes, the earnings in 529 plans are not taxable for federal purposes. In other words, investments in these plans grow tax-free and are never federally taxable so long as you use withdrawals from the investments for eligible college expenses, which includes most costs associated with college like tuition and room and board. However, if you withdraw money from the plan for a purpose other than college, you will be subject to federal income tax and an additional 10% federal tax penalty on earnings.
Individual states may also offer tax breaks such as state income tax deductions simply for making a contribution (even if you’re not the parent, which means that grandparents can benefit from making contributions, too). In some states, you are eligible for a deduction regardless of where the plan is located – check your state rules to be sure.
There are a few other cautions:
- Make sure that you check out the applicable fees for the plan. I’ve found the fees to be relatively low as investments go – but you need to read the fine print.
- As of July 1, 2006, the federal government treats 529 plans the same as state savings plans for purposes of financial aid. This means that distributions from the plan for the purpose of paying qualified education expenses will not count as income to the parent or student. However, for purposes of institutional aid, colleges generally treat 529 plans as an asset of the owner (usually, the parent).
- There may be restrictions on your right to roll over funds or change beneficiary designations.
There are entire web sites and publications devoted to 529 plans. I’m not an expert – and I certainly don’t know much beyond my own state plan. If you have specific questions about a 529 plan, check with your financial advisor. But at least now, you have the basics.
The last time that I checked, a 529 plan owned by the grandparents did not count against the child for student aid purposes. Also payment of tuition directly by the grandparents is not treated as a gift for gift tax purposes. There are lots of good reasons to have granny help with college.
Mary Kay,
You’re absolutely right. The plan is treated as an asset of the owner for purposes of financial aid. While the assets of your parents matter when filling out those forms, the assets of your grandparents do not (unless, of course, your grandparent is your legal guardian).
Why did you opt to use a 529 plan rather than just contributing more to a tax-deferred retirement plan?