Articles of interest
The rules governing 529 plans are complex and continue to evolve. In 2006, new legislation made withdrawals from 529 plans permanently tax free when used for qualified education expenses. This provision was set to expire in 2010 before the legislation was finalized. In 2007, the College Cost Reduction and Access Act of 2007 clarifies that a 529 savings account is considered an asset of the parent, unless the student is considered an independent student, regardless of whether the owner of the account is the student or the parent. Parental assets are treated more favorably than the student's in the calculations used to award financial aid. Also, qualified distributions from a 529 savings plan are not reportable as income or support. The same treatment has been extended to prepaid tuition plans and Coverdell education savings accounts. Although the act does not address treatment of 529 accounts owned by a grandparent or someone other than the student or parent, these accounts are generally ignored for financial aid purposes. You put the money in, it grows without being taxed for years, and then you take it out for post-secondary education and pay no tax. Because you can put in so much money, this is an unbelievable benefit.
The fact that earnings on 529 plans are not taxable makes these extremely attractive alternatives to UGMA accounts.
Many states have 529 plans and each plan is a little different. There are also plans with mutual fund companies. We look for the plans that have the highest allowed contribution limit - generally $250,000. In general, we like the mutual fund plans better because they are more flexible, have higher contribution amounts and generally better investment vehicles.
The contribution rules are complex: Let's say you currently have a UGMA account. The entire UGMA account can be transferred to a 529 plan, up to the contribution limit per child. This is not considered a gift because the assets are already in the child's name. If you transfer less than the contribution limit from a UGMA account, you may gift additional money to a 529 plan. If you transfer assets from a UGMA account, you have to sell the assets, so there may be some capital gains tax consequences.
For new contributions to a 529 plan, each person making contributions can put in up to $60,000 in one year with no tax consequences. So two parents can contribute a total of $120,000. Two parents and a grandparent can contribute $180,000. If a $60,000 gift is made it will be considered front-loading five years of $12,000 annual gifts. Thus, a person who gives $60,000 cannot give any more money to that child for a five year period without gift tax consequences.
Once a child has the contribution limit in 529 plan balances, no more new money can be contributed for that child.
In terms of minimum contributions, a 529 plan can typically be started with as little as $250, approximately $50 per month ongoing contribution to the plan is made.
Anyone can contribute to a 529 plan, regardless of income level.
Two parties are involved in every 529 savings plan account – the donor, or account owner, and the beneficiary, or future college student. Contributions made by the donor are treated as gifts for tax purposes, which means they qualify for the $12,000 annual gift tax exclusion.
Moreover, as long as no additional gifts are made to that beneficiary for a five-year period, the donor can contribute up to $60,000 – or $120,000 per couple – per beneficiary, without federal gift-tax consequences. This means that larger contributions can be invested sooner and will begin growing federal tax-deferred. In addition, the account is not considered part of the account owner’s taxable estate.
Let’s look at one set of grandparents who wish to reduce the size of their estate and have six grandchildren. With the 529 savings plan as an option, $120,000 could be contributed to a 529 savings plan in a single year for each of the six grandchildren, thus sheltering $720,000 from taxation.
Money withdrawn from a 529 plan that is not used it for education expenses, is subject to a 10% penalty, plus ordinary income taxes at the parents' tax rate.
If the plan was funded by rolling over a UGMA account, the money in the plan cannot be transferred to another beneficiary due to the rules of UGMA accounts.
Money in a 529 Plan that was funded by gifts can be transferred to other family members for education expenses include cousins, parents, siblings, children, siblings' children, aunts, uncles, grandparents, in-laws, and spouses of any of those people. Money can be left in a 529 plan for life or until the beneficiary has children of his or her own going to college.
Financial aid implications: If a grandparent sets up the plan and is the participant, the grandparent is considered the owner of the assets and there are no financial aid implications until money is withdrawn. If the parent sets up the plan and is the participant, the parent is the owner of the assets and the financial aid ratios will be applied as usual. If the assets in the 529 plan come from a UGMA account then they are considered assets of the parent as well. No matter who is on the 529 plan as the participant, anybody who wants to make a contribution to the plan may do so. This means the grandparents can set it up, but the parents also can contribute.
Investors should carefully consider the investment objectives, risks, charges and expenses associated with 529 plans before investing. This and other information about 529 plans is available in the issuer's official statement and should be read carefully before investing.
Favorable state tax treatment for investing in a 529 college savings plan may be limited to investments made in a 529 plan offered by an investors home state. Investors should consult a tax advisor about any state tax consequences of an investment in a 529 plan.