Tax-advantaged college savings

The 529 college savings plans were a good idea from the start, but severely hobbled by a year-end 2010 expiration date for the tax-free withdrawals that made the plans so attractive. As part of sweeping pension reform signed into law by Pres. Bush, withdrawals from 529 plans now permanently are tax-free. Nearly all states have 529 plans and roughly 30 provide additional incentives, such as a tax deduction to instate residents who invest in their respective plan.

The Administration's action could not have come a moment too soon, asserts the Financial Planning Association, Denver, Colo. Investments were starting to wane in the plans over the past two years, as parents and other family members began considering the expiration and started looking for other options to save college money for their children. The 529 is named for its place in the Federal tax code and comes in two varieties--college savings and prepaid tuition plans. Prepaid tuition plans are just that--tax-free as long as the money is used to finance college expenses. Each plan has various investment choices that range from low to higher risk.

The Deficit Reduction Act also provides positive news on the financial aid front, as it prevents a 529 account from being treated as a student asset on a Free Application for Federal Student Aid (FAFSA), which could limit an individual's chances for aid. Also, a tax-free distribution from a 529 plan to pay current-year college expenses will not impact income levels that could reduce financial aid eligibility in the next school year.

Federal tax law allows for a general accelerated gift option that permits individuals to average gifts over $12,000 per beneficiary ($24,000 for married couples based on 2006 levels) over a five-year period without getting socked with a Federal gift tax. So, an individual can contribute up to $60,000 per beneficiary in one year and a married couple up to $120,000 without incurring gift tax. If you give the full amount, though, you will not be able to give any gifts to the same individual during the five-year period without incurring a gift tax or using up a part of your lifetime exclusion.

If a beneficiary does not need the money for college, everyone up and down a beneficiary's so-called "lineal family tree"--parents, aunts, uncles, brothers, sisters, and any offspring--may benefit from the tax breaks and educational rewards of these plans. Depending on state laws, relatives and friends may get a tax benefit for contributing funds to a particular beneficiary's plan.

Moreover, the person who opens the account retains rights over the use of the funds. That means that parents can keep control of this substantial asset until the funds are spent. The holder also has the power to transfer accounts or excess amounts to pay for higher education costs for other children or family members.

Performance, however, As the one area where the choice of a 529 is not always a lock. There are mutual funds and other investment options that can earn more for the future student and possibly outweigh any of the tax advantages available with a 529 plan.

COPYRIGHT 2007 Society for the Advancement of Education
COPYRIGHT 2008 Gale, Cengage Learning