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Basic Overview of Section 529 College Savings Plans

Rules and Guidelines for Section 529 Plans

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Few things have excited both parents and financial planners like the creation of Section 529 College Savings Accounts. While these accounts do not cause money for college to magically appear (you still need to diligently save), they make the management of that money immensely easier and more effective.

Prior to the advent of Section 529 plans, parents who wanted to save for a child’s college education had few options. These options were basically limited by whose name, the child’s or the parent’s, went on the account.

If a parent was the account owner, there were no real tax benefits offered for saving towards college. If the child was made the account owner, some tax benefits were given, but the money legally became the property of the child at either age 18 or 21. The unattractive nature of both of these options generally kept parents from working too hard to accumulate college savings.

Everything changed in 1996 with the passage of the Small Business Job Protection Act by Congress. As a provision of this act, Section 529 college accounts were created. These accounts offered parents attractive tax benefits for saving money towards college, as well as allowing them to retain permanent control over the assets.

While the details and rules regarding the Section 529 plans go beyond the scope of a single article, here are some the most basic points to be aware of:

Eligibility:

The eligibility rules surrounding Section 529 plans are much more liberal than those surrounding other savings vehicles like, Roth IRA’s.

In short, anyone can contribute to a Section 529 plan, regardless of how much money they make. However, they do need to be aware of US gift tax limitations, and how larger gifts may affect their eventual estate taxation.

Distributions:

When a Section 529 account is initially opened, the parent or account owner is required to designate a beneficiary. This “designated beneficiary” is usually the person who is expected to attend college some day.

When distributions are made from the account for qualified educational expenses for this beneficiary, there is no taxation on growth of the original investment. Educational expenses are broadly defined in Section 529 plans and can include things like uniforms, books, and even transportation.

If distributions are not considered qualified, Federal income tax will be due on the growth of the distributed investments, as well as a 10% penalty.

Ownership Flexibility:

If a designated beneficiary does not go to college, or some money remains unused, the parent or account owner can change the beneficiary. Again, the IRS rules are extremely flexible and allow the beneficiary to be changed to any immediate family member, as well as descendents of the original beneficiary.

Effects on Financial Aid Eligibility:

Generally, a Section 529 account is considered an asset of the parent, which means that 5.6% of the value is expected to be used towards college. This provides a significant advantage over the older UGMA / UTMA custodial accounts, which required that 20% of the assets be used towards college.

Section 529 Providers:

Section 529 accounts are run by each individual state. Each state’s plan is a little different, and many of the states use different investment managers to oversee the assets. While you can generally use any state’s plan to go to college in any other state, you should check into whether or not certain state income tax benefits might apply to you.

Additionally, because Section 529 plans are run by state-chosen investment managers, your investment options are limited to the mutual funds offered within each unique plan.

Summary:

Section 529 College Savings plans should be at the top of the list for any parent or grandparent wanting to save for a loved one’s education. While there are some rules that require understanding, the tax benefits and ownership flexibility of these plans make them well worth the work.

Be sure to read on in this series for an in-depth explanation of the advantages, disadvantages, and requirements of using Section 529 plans.

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