529 Plans: Funding Higher Education
As higher education costs continue to soar, many parents find themselves faced with the nagging question, “Will I have enough money to pay for my child’s college education?” Although most people today are likely to agree that an investment in higher education usually reaps its rewards in higher long-term earnings—and, hopefully, greater job satisfaction—one key concern is how to choose a smart savings alternative. 529 plans are flexible investment options with tax benefits.*
These state-sponsored plans offer attractive tax benefits and allow you to contribute substantially higher sums than with other savings vehicles, such as the Coverdell Education Savings Account (ESA) and custodial accounts. Tax-free distributions from 529 plans may generally be used for any “qualified” higher education expense, including tuition, room, board, fees, books, supplies, and equipment. Due to a provision of the American Recovery and Reinvestment Act of 2009 (ARRA), beneficiaries of 529 plans may also use tax-free distributions to cover the cost of computer equipment and Internet access. You don’t necessarily need to be a resident of a state to participate in its 529 plan. In some states, you may even name yourself as the beneficiary, if you are planning to further your education sometime in the future.
Although details of these plans vary by state, they generally come in two forms: prepaid tuition plans and college savings plans. Prepaid tuition plans allow participants to “lock in” tuition rates at eligible state colleges or universities with a lump-sum investment or monthly installment payment. The funds are pooled and invested over the long term, so the earnings meet or exceed expected future tuition increases. The contract value may also be applied to private or out-of-state schools (although possibly not at full value, depending on the state). College savings plans allow contributions to vary, and the full value of the account can be applied at any accredited institution of higher education nationwide. It is important to note that participation does not guarantee admission to college; prospective students will still have to meet the school’s entrance requirements.
Substantial Contributions Allowed. Contribution limits are significantly higher than with other college savings alternatives. Some states allow you to set aside over $100,000 per beneficiary, and they generally have no age or income restrictions.
Tax-Free Distributions. Earnings grow tax deferred, and distributions are tax free if used for qualified education expenses. In addition, some states offer their own tax breaks, although you may need to be a resident of that state.
Gift Tax Benefits. 529 plans allow you to transfer up to five years’ worth of annual gift tax exclusions in one calendar year, as long as no additional gifts are given to that individual during the five-year period. Individuals may gift up to $70,000 in one year and married couples may gift up to $140,000.
Switching Funds Tax Free. You may switch funds from one 529 plan to another 529 plan free of any taxes. You are allowed to make such a switch as frequently as once a year without changing beneficiaries, and you may also make interstate plan transfers.
Expanded Beneficiary List. Due to tax reform, the list of possible beneficiaries has been expanded to include cousins. For example, grandparents with multiple grandchildren can set up a 529 plan for their first grandchild. Should that first grandchild choose to delay pursuing an education, the grandparents may transfer the plan to another grandchild.
Professional Asset Management. 529 plans offer a “hands-off” savings approach. Funds invested in the plan are professionally managed through the appropriate state treasurer’s office or by an outside investment firm hired by the plan.
Penalty for Refunds. A Federal 10% penalty may be imposed on the earnings portion of a nonqualified withdrawal in addition to ordinary income tax. However, you may be able to roll over the account to a new beneficiary to avoid a nonqualified withdrawal.
Effect on Financial Aid. Any investment may affect a student’s eligibility for financial aid. A 529 account, whether owned by a dependent student, a parent, or a Uniform Gifts or Transfers to Minors Act account (UGMA/UTMA), is reported on the Free Application for Federal Student Aid (FAFSA) application as a parental asset. Parental assets are assessed at a maximum 5.64% rate in determining the student’s Expected Family Contribution (EFC). For more specific information, refer to the particular state plan, and consult a knowledgeable professional.
Since 529 plans also operate under individual state laws, costs and details vary by state. For more information, and to compare state plans, do a little “homework” and visit these websites: Savingforcollege.com and Collegesavings.org.
*529 Plans are state-sponsored investment programs. There is no guarantee by the issuing municipality or any government agency. You should consider the potential benefits (if any) that your own state’s plan (if available) offers to residents prior to considering another state’s plan. There may be tax benefits to plans offered by your resident state. As with all tax-related decisions, consult with your tax professional.
Annual asset charges for a 529 plan may be higher than corresponding share classes of underlying mutual funds. Municipal fund securities (529 plans) are sold by offering statements, which are available from your registered representative. Please carefully consider investment objectives, risks, charges, and expenses before investing. For this and other information about municipal fund securities, please obtain an offering statement and read it carefully before you invest. Investment return and principal value will fluctuate with changes in market conditions such that shares may be worth more or less than original cost when redeemed. Diversification cannot eliminate the risk of investment losses.
The information contained in this article is for general use and while we believe all in formation to be reliable and accurate, it is important to remember individual situations may be entirely different. Therefore, information should be relied upon only when coordinated with professional tax and financial advice. Neither the information presented nor any opinion expressed constitutes a representation by us or a solicitation of the purchase or sale of any insurance or securities products and services. Written and published by Liberty Publishing, Inc. Copyright © 2013 Liberty Publishing, Inc. EDF529B1-04
The information provided is not written or intended as specific tax or legal advice and may not be relied on for purposes of avoiding any Federal tax penalties. MassMutual, its employees and representatives are not authorized to give tax or legal advice. Individuals are encouraged to seek advice from their own tax or legal counsel.