Q What are these
529 Plans?
A College
Savings Plans, also called 529 Plans, are investment plans
designed by each state to help families save for future
college costs in tax-advantaged accounts. (The name "529
Plan" is derived from the section of the IRS code
that allows for this plan.)
Federal tax law provides special tax benefits for investing
in 529 Plans and some states also provide tax benefits
to contributors to their plans. Each state decides what
benefits will be available and how much can be invested
in a plan for each beneficiary, then the state contracts
with one or more financial service providers, usually a
mutual fund company, to design a state-specific plan. Funds
are contributed to a College Savings Plan by the "owner" of the
account for a "beneficiary" who is expected to
have future college expenses.
Some
of the benefits of 529 Plans are:
- The
funds grow tax-free in the account, and if the "beneficiary" uses
the funds for a qualified education expense, the funds
are federal tax-free upon withdrawal.
- The
contributor/owner might be eligible for tax deduction
benefits at the state level (depending on the state's plan). Before investing in a 529 Plan, investors should carefully consider whether their home state offers any state tax or other benefits that are only available for investments in their state sponsored 529 plan, and
- The
funds are no longer part of the owner's estate even though
the owner retains control of the funds and can change
the beneficiary
Q Am
I eligible to contribute to a College Savings Plan?
A Anyone
can contribute to a College Savings Plan for any beneficiary.
Usually, a parent or grandparent contributes for their children
or grandchildren but you can also contribute for grown children,
unrelated individuals or in some cases, even for yourself
if you expect to have qualified education expenses.
Q How
much can I contribute?
A Any individual can contribute up to $60,000 all in one year
to a single beneficiary by using a special election that
spreads the contribution for gift tax purposes over a five-year
period during which that contributor can make no other gifts
to that beneficiary without incurring gift tax consequences.
The $60,000 amount is five times the annual gift tax exclusion
amount, which is $12,000 currently. Without the special
five-year election, any individual can contribute up to
$11,000 each year to any one beneficiary. (Also refer to
the Estate Planning question below.)
Additionally,
each state plan has a maximum limit for contributions (in
most state plans the limit is over $200,000) and once that
limit is reached (through growth or contributions), no additional
contributions may be made unless the account value falls
below the plan-specific limit due to price fluctuations
or withdrawals.
Q Is
it true that College Savings Plans can be used as an estate
planning tool?
A Yes. The contributions leave your estate but since you are
still the owner of the account, you control the assets and
retain the right to revoke the gift. If you are concerned
about irrevocably giving away your assets, College Savings
Plans may be a way to achieve some of your estate planning
and gifting goals without making irrevocable gifts. If you
later decide to revoke the account, the value would be returned
to your estate. However, if you have made five-year's worth
of gifts in one year, and you die before the end of that
five-year gift period, you will have lost your right to
revoke the gift; a portion of the money will be returned
to your estate for tax calculations, but the gift remains
in the beneficiary's account.
For a comprehensive review of your personal situation, always consult with your legal advisor. Neither PrimeVest, nor any of its representatives may give legal advice.
Q Do
I pay taxes on the earnings?
A Generally, no, although there can be penalties and/or taxes
for certain withdrawals. Usually, the funds grow tax-free
and are tax-free upon withdrawal when used for qualified
expenses. (Through 2010 this is the rule, although, an extension
is expected.) However, if you withdraw the funds for non-qualified
distributions, federal law imposes a 10% penalty on the
earnings; which means you get back 100% of your principal
and 90% of your earnings. Plus, earnings could be subject
to income tax at the account owner's or beneficiary's tax
rate.
In
some states, non-qualified withdrawals might be subject
to a recapture of tax, if your original contribution was
tax-deductible. Some states also impose a penalty at the
state tax level. The 10% federal penalty does not apply
in certain circumstances, like disability or if you withdraw
funds not needed for college because the beneficiary received
a scholarship. (The law is not clear on the penalty in the
case of a beneficiary death.)
The
rules are complicated and are changing at both the federal
and state levels, so it is advisable to check with a tax
and financial advisor prior to a non-qualified distribution.
Q What
is a "qualified higher education distribution"?
A The
term "qualified higher education expense" generally
means tuition, fees, books, supplies and equipment required
for the enrollment or attendance at an "eligible higher
education institution"; plus room and board expenses,
with limits based on the type of living situation. Basically,
an "eligible higher education institution" includes
most public and private colleges and universities, graduate
schools, community colleges, junior colleges, and area vocational
or technical schools. If distributions exceed the qualified
expenses, the additional amount withdrawn is deemed a nonqualified
distribution.
Q What
is a "nonqualified distribution"?
A A "nonqualified distribution" is any distribution
other than a "higher education expense distribution".
When a nonqualified distribution is taken, a ratio of contributions
and earnings is withdrawn. The earnings portion is then
subject to taxes and a 10% penalty. Distributions made because
of disability or scholarship are not subject to the 10%
penalty. (The law is not clear in the case of a beneficiary's
death.) However, the earnings portion of such distributions
is taxable.
Q Will
the beneficiary's chances for financial aid be affected?
A They can be, but the impact depends on the ownership of
the account. If the beneficiary's parent owns the account,
the assets will be counted in the parent's asset base and
will be counted at a lower percentage than they would if
the funds were in the beneficiary's name or in a custodial
account. If the owner is a non-parent, the assets won't
count against the beneficiary at all in the initial determination
for financial aid. However, the distributions from the untaxed
earnings might have to be reported in the next year's report
of available funds. This can be a complicated area, but
when you consider that much of the beneficiary's aid may
be in the form of loans, you might decide that saving instead
of borrowing is your preferred method of financing an education.
Q Can
I move funds in a Coverdell
Education Savings Account (CESA) or a Uniform Transfers
to Minors (UTMA) account into a College Savings Plan?
A Generally, yes, but there are ownership and tax issues that
vary with each of these. Since the child is the owner of
the funds, the new account has to be structured differently
and not all plans are willing to accept funds from an CESA
or UTMA. Different rules might need to be put in place so
that the account beneficiary cannot be changed and so that
the beneficiary retains their ownership rights. It is best
to seek professional advice (legal, tax and/or financial)
before transferring a CESA or UTMA account to a College
Savings Plan.
Q How do I open a College Savings Plan?
A Contact
one of our Investment
Executives at a location nearest you.
For
Federal tax questions, we encourage you to visit the Internal
Revenue Services Website.
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