529 plans offer flexibility in uncertain times
If there’s one thing everyone desires in today’s uncertain economy, it’s flexibility. The 529 plan — one of the mainstays of college funding over the past decade or so — provides flexibility in a variety of ways.
Here’s the plan
529 plans provide a way to help you fund a loved one’s college education. They come in two varieties.
One is the college savings plan, which allows you to save for higher education costs in a tax-advantaged way. You can use plan funds for qualifying expenses such as tuition, mandatory fees, books, equipment, supplies and many room and board costs. The other variety is the prepaid tuition plan, which locks in future tuition at today’s prices.
The college savings plan tends to be preferable from a flexibility standpoint, in part because it doesn’t come with the residency requirements that apply to many prepaid tuition plans. In addition, it avoids the uncertainties that may arise regarding prepaid tuition plan benefits if the beneficiary ends up attending a school different from the one named in the plan.
College savings plans also provide flexibility in investment options and allow for tax-free growth. Further, you may withdraw funds more easily than with a prepaid tuition plan. College savings plan withdrawals will be tax-free, so long as they’re used for qualified college education expenses. If funds are withdrawn for a nonqualifying purpose, the earnings will be subject to income tax plus a 10% penalty.
If you wish to transfer your college savings plan balance to another plan, it’s usually easy to do so (though you can make a transfer only once every 12 months). On the other hand, prepaid tuition plans aren’t designed to be transferred from one plan to another. If the beneficiary ends up attending college somewhere else, however, there are mechanisms for redeeming the value of the prepaid tuition.
College savings plans and prepaid tuition plans both offer another flexible feature: You may change beneficiaries easily and without tax implications, as long as the new beneficiary is a qualifying “family member.” This may be beneficial if, for instance, one sibling gets a scholarship or otherwise doesn’t need to use his or her 529 plan money.
Another potential tax benefit is the ability to get a state income tax deduction or credit by making contributions. Typically this applies only to contributions to your home state’s plan. But it may be possible to get a benefit for a contribution to the plan of a state in which you don’t live, yet where you’re liable for paying tax.
529 plans have more to offer than just flexibility and tax benefits; they also offer substantial contribution limits. In 2012, most states allow you to contribute between $200,000 and $300,000 to a plan. That’s a hearty amount of cash and deservedly so, considering how high tuition is projected to be decades hence.
529 plans come with risks as well. Although the prepaid tuition plan is akin to a CD or other guaranteed return account, college savings plan assets can be invested in a wide range of choices and, as a result, can be significantly riskier. (Investment fees may cut into returns as well.)
In fact, an issue with 529 plans of late is the emergence of “underwater” plans, which arise when a plan’s current value is less than the amount that has been contributed to it. Many underwater 529 plans will likely recover eventually. So if the funds won’t be needed for several years, staying put may be your best option.
But, if the money is needed right away or you’re prepared to abandon the account, a viable strategy may be to simply withdraw the funds and shut down the plan. If you do so, you can likely claim the loss as a miscellaneous itemized deduction.
What’s more, you probably won’t face taxes or penalties, regardless of how the money is ultimately spent, because you’re not withdrawing earnings. The loss deduction may even help you recover and start your college funding efforts anew. Still worthwhile
Certainly, 529s have been subject to the same bumpy ride that so many investment vehicles have had to endure in recent years. But, thanks in part to their flexibility, these plans are still worth considering when looking to fund a college education.
| Sidebar: 529 plans offer estate planning opportunities
The benefits of 529 plans aren’t limited to education funding; they extend to estate planning as well. For example, gifts to 529 plans are generally eligible for the $13,000 per year per beneficiary gift tax annual exclusion.
And a long-standing opportunity available only for 529 plans has been to accelerate five years’ worth of annual exclusion gifts into a 529 plan, allowing for a sizable $65,000 contribution (or $130,000 if you split the gift with your spouse). The gifts reduce your taxable estate without using up any of your lifetime gift or estate tax exemption.
If you’re contributing to a 529 plan for the benefit of a grandchild, annual exclusion gifts are also excluded from generation-skipping-transfer (GST) tax — without using up any of your lifetime GST tax exemption. The GST tax generally applies, in addition to any applicable gift or estate tax, to transfers benefiting people two or more generations below you.
No article, email, web site content, or other communication from Fox, Byrd & Company, P.C. (the Firm) may be considered advice or a recommendation to any person, business or other entity. The Firm renders advice and recommendations only to its clients. The reader may not rely on any article, email, web site content or other communication from the Firm to create a client relationship with the Firm. Advice and recommendations are rendered by the Firm only when the Firm has been specifically engaged to provide advice and/or recommendations.©Copyright, Fox, Byrd & Company, P.C., Dallas, Texas.