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Other Articles
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Saving for College
College Savings Plans: The Benefits of a 529 Plan
By Kurt Box
Principal, Cypress Advisory Services Ltd. LLP
Do you know what a "529" college savings plan is and how they work? If you’re concerned about investing enough money to send your children to college, it’s critical you know about this new, powerful way to save for higher education.
529 plans, named for a tax code section, were started several years ago as state prepaid tuition plans. Today, 529 plans are usually categorized as either prepaid programs or savings programs, although some plans have elements of both. Section 529 prepaid tuition plans are state-sponsored programs that allow anyone to purchase tuition credits or certificates on behalf of a beneficiary. Section 529 savings plans are state-sponsored savings programs where earnings grow tax free if used for higher education. Today, it's up to each state to decide whether it will offer a 529 plan (or possibly more than one), and what the plan will look like.
Money in a 529 savings plan is invested in professionally managed accounts and these account values can fluctuate with the market. The more time you have before your child needs the money, that is the younger they are, the greater the proportion you can to allocate to equities. While the values of stocks tend to fluctuate more than other investments such as bonds, over time they have historically given offered a better return.
Many 529 savings plans offer age-based investment options where more of the account is invested in stocks when the child is young, and automatically shifts the investment to more conservative, less volatile options - such as bonds and/or cash - as the child grows older.
Anyone can make a contribution to a 529 on behalf of someone else, from a grandmother to a rich uncle. You don't even have to be a relative to make a contribution. In fact, anyone can create and fund a 529 plan for his or her own benefit.
Under the basic "gifting" rules of the Tax Code, an individual can give up to $11,000 apiece (a married couple can give $11,000 each for a total of $22,000 per child) to as many individuals you want without triggering the gift tax. (It's the donor, not the recipient who pays the gift tax.) However, 529 plans get special treatment because donors can contribute five times the annual gifting limit -- or $55,000 per child in one year-- into a 529 plan without any gift tax.
The most significant benefits to using a 529 savings plan for college savings over traditional college savings accounts include:
Tax-free earnings growth: There is no federal income tax due on any earnings while they are in your account.
Tax-free distributions: Distributions for qualified education expenses made after December 31, 2001, are federal income tax free.*
Any institution in the U.S.: Your assets can be used at any accredited institution of higher learning in the U.S.
No income limits: There are no income limits restricting who is eligible to participate.
Low minimum investments: Because you can open an account with virtually any amount, it’s easy to start saving today.
Investment choice: You choose from various investment options within each state’s 529 plan.
Control: The donor controls the account as owner and can change the beneficiary at any time.
*Under a "sunset provision", these changes are scheduled to expire on December 31, 2010, in the absence of reenactment.
However, many other issues must be considered. These include:
Is a 529 savings plan a better alternative for you than a Coverdell Savings Account or setting up an UGMA or UTMA trust?
How much control of your investments do you require?
Which state offers the best 529 savings plan for your particular situation?
How do 529 saving plans effect federal and college financial aid?
What about tax-deductions on 529 savings plans that have declined in value?
If funding for higher education is one of your major goals, then clearly, you should consider using a 529 plan, as this an extremely effective and efficient college funding vehicle.
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