Funding for Higher Education (Part V)
8/2/2004
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5. The 529 Plan
529 Plan is named after the IRS code that encourages people to save for higher education. Enacted in mid 1990’s, the tax-favored program has become more popular when the Congress in 2002 made it even more tax-favorable.
While there is no deduction allowed for Federal income tax when the plan is funded, earnings inside the plan are both Federal and state tax deferred. For Federal tax purposes, earnings would also be tax-free upon qualified withdraws under the new law (the old law would make it taxable to the beneficiary).
However, as 529 Plans are run by state governments, rules on contribution and withdraws vary dramatically from state to state.
For example, about half of the states do not allow state tax deductions on contributions to the plan. On the other side, there are two-dozen states that allow state tax deduction but the allowed amount is all over the map: from $500 (Rhode Island) to $10,000 (Mississippi) to even no limitations (Colorado and South Carolina). Missouri is a relatively liberal state that allows up to $8,000 deduction per taxpayer per year.
Then, rules on the qualified withdraws (that is, fund from the plan used for beneficiary’s college or graduate school tuition, fees, room and board, books and supplies, computers, etc.) are different again from state to state. In most states, Missouri included, they are tax-free. But some states, incongruously, choose to tax the earnings upon the qualified withdraw.
Federal tax law allows anybody to be an account owner and contributor as long as a designated beneficiary is an individual. So, besides parents, others such as grandparents can also help on savings for college.
There is a limit on how much can be contributed into a beneficiary’s account. Generally, it’s up to $250,000 (Missouri’s maximum is $235,000). Contributions are treated as gifts eligible for the gift tax annual exclusion. That is to say, each giver (the donor) can give $11,000 (2004’s limit) per year to a beneficiary (the donee) without worrying about Federal gift tax issue.
Regardless of the different rules that vary among states, the 529 plan is a powerful tool of saving for college. Combined with a family’s financial or estate planning, 529 plan makes perfect sense to save taxes, transfer assets and prepare for one of the most important investments of a family: child(ren)’s college education.
Keep in mind that each year's 529 Plan contribution deadline is the end of a calendar year. Plan ahead and seize the tax-saving opportunity!
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