Barry Dolowich for the Monterey Herald writes: Question: We were just blessed with our first grandchild and would like to set up a college fund for our new prince. We were recently advised that we could open a "Section 529" plan to safely invest for our grandson's college expenses. Can you please provide us with the basics of this type of plan and any tax consequences?
Answer: Internal Revenue Code Section 529 college savings plans are state-sponsored plans designed to encourage residents to save for college. Regardless of age and income, anyone can make contributions to a 529 plan on behalf of a beneficiary. However, there are three limitations relating to contributions to a 529 account:
• Gifting limit. Since Section 529 does not impose an annual contribution limit on 529 plans, contributors need to be aware of the federal gift tax exclusion. To avoid gift tax or a reduction in the lifetime gift or estate exclusion, contributors may take advantage of the 2014 annual gift exclusion of $14,000 per beneficiary, or $28,000 for married couples.
• Special gifting provision. Section 529 allows a special gifting provision that is not available in any other estate planning vehicle. A contributor may front-load the gift by contributing five years of annual gifts in one year, or contribute $70,000 on behalf of a beneficiary to a 529 plan in one year, $140,000 for married couples. When taking advantage of this provision, the contributor is required to file Form 709, a gift tax return, with the IRS.
• Account limit. To prevent accumulating more money than needed to send the beneficiary to college, the account limit, which varies by state, is generally in excess of $200,000. Once the contributions and earnings in a 529 plan reach the account limit, new contributions cannot be made to the plan.
Although contributions to 529 plans are not federally income tax deductible, some states provide a deduction or credit for residents who participate in their state's 529 plan. This deduction or credit varies from state to state.
Accumulations or earnings on contributions to a 529 plan are not subject to federal income tax while they remain in the account. When distributions are used for qualified higher education expenses at an eligible educational institution, they are federally income tax free. If a distribution is taken from a 529 plan and is not used for a qualified expense, the portion of the distribution representing earnings is subject to ordinary income tax and a 10 percent penalty. Exceptions to the penalty include distributions pursuant to the death of the beneficiary, disability of the beneficiary, or receipt of a tax-free scholarship or educational assistance allowance by the beneficiary that exceeds the distribution.
Qualified higher education expenses generally include tuition, books, supplies, equipment and, in many cases, room and board.
Because contributions to a 529 plan are considered gifts, the assets are removed from the contributor's estate. Another unique feature of the 529 plan is that although contributions are gifts, the account owner (contributor) maintains control of the account for the life of the account. This control, coupled with the special gifting provision, makes the 529 plan a viable estate planning tool for those who want to help send a child to college.
Barry Dolowich is a certified public accountant in Monterey, CA
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