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Education Planning: College Investment Advice in PA
529 Plans
The 529 Plan was designed to provide a strategy to save for higher education expenses. It is found in Section 529 of the Internal Revenue Code, hence the name "529 Plan." Programs are administered by a state agency or an organization designated by the state such as a for-profit company or an investment company. Plans differ from state to state. Some have no specific residency requirements and are available to prospective students from any state while other state plans are available only to residents. Most states have a 529 Plan in place, or are in the process of designing such a plan. The withdrawals from all plans for qualified educational expenses are federal income tax free.
There are certain requirements set forth in the Internal Revenue Code that apply to all 529 Plans. Among these are: all contributions have to be made in cash; there must be a separate account for each beneficiary; there is a penalty for use of funds for purposes other than educational expenses of the beneficiary (allowances are made if the beneficiary receives a scholarship, or upon the death or disability of the beneficiary); and the investment may not be used as security for a loan.
A contributor establishes an account for the "beneficiary", usually a child or grandchild, for the purpose of paying expected college expenses. The contributor is the owner of the account and maintains control of the account. To establish an account, the contributor may use the 529 Plan in his/her state of residence, if that state has a plan, or he/she may use a 529 Plan from another state that does not have a residency requirement. Selected mutual fund companies manage many of these 529 Plans and the account owner, based on his/her investment objective, chooses a specific fund portfolio available from the mutual fund company and then makes contributions to the fund according to his/her wishes.
An example of how one state runs its program:
There is no residency or age requirements for the contributor or beneficiary, and the contributor and beneficiary may be the same person. The minimum initial contribution is a $250 lump sum, or if the contributor prefers to use an automatic deposit option, the minimum is $50 per month. Maximum contributions for one beneficiary can total $235,000. There is a 10% penalty if the money is used for a purpose other than the beneficiary's higher education expenses, unless the beneficiary received a scholarship, or in the case of the beneficiary's death or disability. Withdrawals from a 529 account for qualified education expenses are federal income tax free. State income tax treatment depends on each individual state, but all states allow earnings to grow income tax free or tax deferred.
The federal tax law makes no stipulation as to who the account owner may be in relation to the beneficiary. The contributor maintains ownership of the account, until such time as distribution of funds takes place. The account owner may change the beneficiary, but the new beneficiary must be a member of the family of the original beneficiary.
Eligible expenses and institutions: Funds in the 529 Plan may be applied to the costs of tuition, fees, books, supplies, and equipment required for attendance at an "eligible educational institution." Most accredited institutions of higher education in the US and some foreign institutions would qualify as "eligible." This includes most private and public colleges and universities, graduate schools, two-year community colleges, and vocational-technical schools. Only post high school education expenses are considered "eligible."
Pros & Cons
The 529 Plan offers many tax advantages:
- Earnings grow federal income tax free. Withdrawals from your 529 account for qualified education expenses are federal income tax free.
- Contributions of as much as $60,000 per beneficiary can be made in the first year.
- Certain states offer advantages such as a state income tax deduction for contributions and an income tax exemption for qualified withdrawals.
- Substantial amounts of money can be contributed to a 529 account, much more than other types of investments designed to finance higher education.
- The account owner maintains control of the account, regardless of the age of the beneficiary.
- The account owner may change the beneficiary, providing the new beneficiary is a member of the family of the original beneficiary.
- If the beneficiary receives a scholarship (or dies or becomes disabled), there is no penalty for withdrawal of funds.
- An account owner may change from one 529 plan to another without tax or penalty. This change may be made once every twelve months.
Disadvantages:
- Some states have specific restrictions apart from the federal tax law. For example, some states do not allow use of 529 funds for certain educational expenses such as books, room and board, supplies, and equipment.
- There may be an impact on a student's eligibility for financial aid if the student owns the account.
Frequently Asked Questions
What's the difference between a prepaid tuition program and a savings program?
Prepaid Tuition: Essentially, parents, grandparents, and other interested parties may lock in today’s tuition rates, and the program will pay out future college tuition at any of the state’s eligible colleges or universities (or an equal payment to private and out-of-state institutions). Amounts of tuition (years or units) may be purchased through a one-time lump sum purchase or monthly installment payments. The program pools the money and makes long-range investments so that the earnings meet or exceed college tuition increases in that state.
Savings Plans: Savings plans allow participants to save money in a special college savings account on behalf of a designated beneficiary’s qualified higher education expenses. Contributions can vary, depending on the individual savings goals. The plans offer a variable rate of return although some programs guarantee a minimum rate of return.
Which type of plan is better?
It depends upon the investment needs and goals of the family. Each state has created innovative college savings programs individually designed to reflect the unique needs of its citizens. The plans represent affordable, flexible, and tax-advantaged options that can ensure the education of our most precious resources æ the children of America. Some states are starting to offer their citizens both types of programs, giving families the option to choose the college savings vehicle that is right for them.
Can my investment in a qualified state tuition program be used throughout the U.S.?
Yes. Generally, in both prepaid tuition and savings programs, your account funds can be used nationwide at eligible institutions. Such institutions generally are accredited two- or four-year public or private nonprofit colleges or universities as well as certain proprietary and vocational institutions.
What if my child does not attend college?
You may choose to hold the investment in the qualified state tuition program until a later date when the student may decide to attend college, or you may transfer the benefits to another member of the student's family. You may also request a refund, and the account will be refunded according to the program’s policy. By federal law, a refund penalty will be assessed, except in the case of the student's death, disability, or receipt of a scholarship.
What if my child receives a scholarship?
If your child receives a scholarship that covers the cost of qualified expenses, a refund can be made up to the amount of the scholarship without incurring a refund penalty. Funds can also be transferred to another family member, or they can remain in the account for future use.
How will participating in a qualified state tuition program affect financial aid eligibility?
Any investment is likely to impact a student's eligibility for need-based financial aid. Financial aid treatment of investments changes through the years so it is impossible to know how assets will be treated in the future. In addition, it is uncertain as to how much or what types of financial aid will be available to families in the future.
Is investment in qualified state tuition programs recommended by financial advisors?
Many financial planners, tax accountants, and other financial advisors support state plans and recommend them to their clients as a program that may fit their college planning needs.
Can funds be used for more than just tuition costs?
Yes. While policies will vary by state, most states allow for funds to be used for any qualified higher education expense such as tuition, fees, room and board, books, supplies, and equipment required for enrollment.
Are there gift and estate tax advantages with 529 plans?
The gift and estate tax treatment of an investment in a 529 plan is a good news, bad news situation. The bad news is that your contribution is treated as a gift to the named beneficiary for gift tax and generation-skipping transfer tax purposes and so you need to be aware of this exposure particularly if you are making other gifts to the beneficiary during the same year. The good news is that your contribution qualifies for the $12,000 annual gift tax exclusion and so most people can make fairly large contributions without incurring the gift tax.
The better news is that if you make a contribution of between $12,000 and $60,000 for a beneficiary, you can elect to treat the contribution as made over a five calendar-year period. This allows you to utilize as much as $60,000 in annual exclusions to shelter a larger contribution. The money (and the growth of your account) gets out of your estate faster than if you made contributions each year.
And the best news is that the asset leaves your estate but doesn't leave your control. This is a truly remarkable benefit when you compare it to the "normal" gift and estate tax laws. This is good for anyone who is being advised to reduce their estate tax exposure through gifting, but cannot stand the thought of irrevocably giving away their assets. Of course, if you later revoke the account its value comes back into your estate. Your estate will also have to include a portion of any contribution made with the five-year averaging election if you don't live past the fourth year.
Source: www.collegesavings.org and www.savingforcollege.com
Plan Reviews
CPAG has reviewed the majority of the highest ranking plans currently available and have found the following to be the most favorable:
NEBRASKA
Name of Program - Nebraska College Savings Plan
Program Type - Savings Plan
State Residency Required - No
To Enroll: Visit Website - www.planforcollegenow.com (to download enrollment package) Or call Tel # - 1-888-993-3746 (to have enrollment package sent to you)
DELAWARE
Name of Program - Delaware College Investment Plan
Program Type - Savings Plan
State Residency Required - No
To Enroll: Website - www.fidelity.cm/delaware (to download enrollment package) Or call Tel # - 1-800-544-1655 (to have enrollment package sent to you)
ILLINOIS
Name of Program - Bright Start College Savings Plan
Program Type - Savings Plan
State Residency Required - No
Website - www.brightstartsavings.com (offers online enrollment feature) Or call Tel # - 1-877-432-7444 (to have enrollment package sent to you)
PENNSYLVANIA
Name of Program - TAP 529 Investment Plan
Program Type - Savings Plan
State Residency Required - Yes
Website - www.pa529direct.com (offers online enrollment feature) Or call Tel # - 1-800-440-4000 (to have enrollment package sent to you)
NEW JERSEY
Name of Program - NJBEST 529 College Savings Plan
Program Type - Savings Plan
State Residency Required - Yes
Website - www.njbest.com
(offers online enrollment feature) Or call Tel # - 1-877-465-2378 (to have enrollment package sent to you)
To view additional features and a more detailed analysis of these and other state plans visit www.savingforcollege.com
Tax Managed Accounts
Advantages:
- Account owner maintains complete control and discretion of assets.
- No restrictions on amount saved.
- Wide choice of investments.
- Low annual capital gains distributions.
Disadvantages:
- Assets subject to capital gains taxation when withdrawn.
Coverdell (aka Education IRA)
Advantages:
- Tax exempt withdrawals for K-12 in addition to postsecondary education.
- Wide choice of investments.
- Can be transferred to a qualified tuition plan.
Disadvantages:
- $2,000 total annual cap on contributions to any one beneficiary.
- Income limits on donor (phase-out range $95,000-$110,000 for single; $190,000-$220,000 for joint filer.
- Age limitations prevent contribution after beneficiary turns 18, and require use of account by time beneficiary turns age 30.
- Treated as student asset for federal financial aid purposes.
IRA
Advantages:
- Contributions and gains are tax deferred.
- Distributions prior to age 59.5 used for qualified higher education expenses are not subject to premature withdrawal penalty.
Disadvantages:
- Assets subject to taxation as ordinary income when withdrawn.
Roth IRA
Advantages:
- Contributions and gains are tax deferred.
- Distributions prior to age 59.5 used for qualified higher education expenses are not subject to premature withdrawal penalty.
Disadvantages:
- Gains are subject to taxation, but contributions come out first as tax-free return of principal.
UGMA
Advantages:
- Taxed at child’s rate.
- First $950 of dependent child's income is tax free.
- Next $950 is taxed at child’s rate
- Kiddie tax applies on income over $1,900 for child under 19.
Disadvantages:
- Potential loss of control at age of majority.
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