Albuquerque Journal

Get the most from a 529 plan

What to know to help a child or grandchild pay for college

- By John Hewitt John Hewitt is the founder and CEO of Liberty Tax Service.

A529 plan, also known as Qualified Tuition Programs, is a way to help a son, daughter, grandchild or friend’s child pay for college.

In short, 529 plans are investment tools designed to help families pay for future expenses associated with college or other qualified post-secondary training for a designated beneficiar­y. The fund can be used to help pay for such expenses as tuition, books, supplies, fees and computer equipment.

The plans are broadly known as 529 plans because they are named after Section 529 of the Internal Revenue code. Before we dive into the tax benefits of 529s, let’s be clear on what they are and what they are not.

As mentioned, a 529 plan is an investment tool in which funds are set aside in an account operated by a state or educationa­l institutio­n. They are not, however, deductible on your federal return (although some states offer a partial deduction on the state returns).

Neverthele­ss, there are several benefits to contributi­ng to such plans. Here’s what you need to know to maximize your 529 plan.

1. Who

The biggest benefit is to you and the person you designate as beneficiar­y. When you establish a 529 account, the earnings generated in the plan are not subject to federal tax and generally not subject to state tax when used for the qualified education expenses of the designated beneficiar­y.

Your child, for example, as the designated beneficiar­y gets the peace of knowing a fund for college expenses awaits, and the fund also provides an incentive to pursue education beyond high school.

2. What

There are two types of 529 plans: prepaid and savings plans. They also differ by state so make sure to check with your administra­tor for the rules

that apply to you.

Generally, here’s how it works. Prepaid plans are offered in about a dozen states and allow participan­ts to purchase tuition credits to be used in the future.

Savings plans are different in that a fixed amount is contribute­d monthly and growth is based on market performanc­e.

This type of 529 plan consists mostly of mutual funds. But unlike capital gains paid on mutual funds or other savings plans upon withdrawal, no tax is due on the distributi­on of a 529 plan unless the amount taken out is greater than the beneficiar­y’s qualified education expenses.

Also, the part of a distributi­on that represents the amount paid or contribute­d to a 529 doesn’t have to be included in income. This is a return of the investment in the plan.

3. Why

Setting up a 529 plan is an investment decision, which means both the benefits and drawbacks must be considered. The biggest drawback, of course, is that contributi­ons to the fund are not tax-deductible on federal returns.

However, more than half the states allow you to deduct some or all of your contributi­ons from your state income at tax time. Contributi­on limits are set at the state level.

On the federal level, you can currently contribute up to $14,000 to a 529 plan without incurring federal gift tax consequenc­es.

4. When

Ideally, the best time to set up a 529 plan is when your designated beneficiar­y is still a baby or young child. Like other types of savings accounts, growth is usually a function of time. So the longer you have to build up the fund, the more money will be available to offset the youngster’s educationa­l expenses, and the more your earnings will grow.

But the fact of the matter is, you can start a 529 plan anytime and begin enjoying the tax benefits. There are no income limits or age limits. You remain in control of the account until you’re ready to withdraw funds. When the college bills start coming, all funds from your 529 plan will be distribute­d taxfree if they are going to be used to cover qualified expenses.

5. Where

Looking for more informatio­n about 529 plans? Greater detail about them can be found in IRS Publicatio­n 970, Tax Benefits for Education.

Each family must balance pros and cons, but overall, the tax benefits of 529 plans might outweigh the cons. A financial adviser or tax pro can help you decide if a 529 makes sense for you.

The beauty of most 529 plans is their single-focus simplicity and flexibilit­y. Besides lump sum contributi­ons, in most cases you can set up a fund using payroll deduction or an automatic deduction from your checking account. You can change your 529 plan investment options twice a year, and you can also change, without penalty, your designated beneficiar­y to another family member.

The National Associatio­n of State Treasurers created the College Savings Plan Network, which provides links to most 529 plan websites, to give you more informatio­n.

Setting up a 529 plan is an investment decision, which means both the benefits and drawbacks must be considered.


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