BGBC Partners, LLP Tax Update: 529 Plans
A 529 plan is a qualified tuition plan that is designed to help with future educational costs. These plans are exempt from federal taxes and often have tax benefits at the state level for in-state residents.
There are two types of 529 programs: prepaid plans and savings plans. Prepaid plans allow you to buy tuition credits or certificates at present tuition rates for use in a future year. Savings plans allow the account owner to invest contributions in various market funds or age-based portfolios. Prepaid tuition plans are usually subject to residency requirements, while saving plans normally are not. Savings plans have grown in popularity over the last several years which has caused some prepaid tuition plans to become obsolete—due to some of the restrictions mentioned above. Most states offer at least one type of 529 plan and several offer some type of tax incentive for plan contributions.
While you do not receive a federal income tax deduction for contributions, the earnings on your contributions are nontaxable as long as the funds are withdrawn for qualified educational expenses. Anyone can contribute to the plan on behalf of the beneficiary. It is not limited to the owner of the account. However, there may be gift tax consequences.
Distributions from the program are tax-free if they do not exceed the student’s qualified educational expenses. Qualifying expenses include tuition, fees, books, supplies, required equipment, and reasonable room and board for students enrolled at least half-time. Distributions in excess of qualified expenses or distributions taken and not used on qualified educational expenses are taxable income to the beneficiary and a 10% penalty tax may also be imposed.
An account owner may change the beneficiary of the plan or roll the funds into another 529 plan for the same or a different beneficiary without income tax consequences. Any U.S. citizen or resident alien 18 years or older can open a 529 account and name anyone as the beneficiary. It can be a relative, friend, or yourself. There is no age limit for the beneficiary, and there is no limit to the number of plans you can set up.
Many states allow a deduction while a few provide a tax credit for contributions made to a 529 plan. Eligible educational institutions may include (in state or out-of-state) colleges, universities, vocational schools, or other postsecondary schools. A school should be able to tell you whether or not it qualifies as an eligible institution.
It is important to do some research before deciding on a qualified tuition plan. Each type of plan is subject to different rules in each state. A 529 plan offers many benefits including tax benefits. However, one of the best benefits is the comfort of knowing that your child’s or loved one’s future may be taken care of. Saving now will ease the burden of tuition and other college expenses in the future. Contact your CPA for more information and guidance on what is right for you.
