Section 529 allows qualified state tuition programs to offer a host of tax advantages.

 

Income tax benefits include a deferral of earnings until distributions are made from the plan for college tuition, books, room or board. At that time, the student is taxed on the earnings, usually the lowest tax bracket. Many states also offer tax deductions, an income exemption, or scholarships for residents contributing to their 529 plan. The income tax treatment may be less straightforward when there is more than one account established for any particular beneficiary.

Most of the states offering the new college savings plans make them available to residents and nonresidents alike and the choice of college makes no difference. Depending on the state, over $100,000 can be contributed for a single beneficiary and is invested on a tax-deferred basis in an age-banded portfolio of mutual funds. This provides a more aggressive allocation of assets for younger beneficiaries. It then becomes more conservatively invested as the beneficiary nears college age.

 

Most states offer these plans, but be aware of the following:

Estate Planning
After affluent taxpayers die, they often leave estates subject to tax rates as high as 55%. Often the best way to reduce this tax liability is to make annual gifts to children and grandchildren. The estate and gift tax advantage includes treating a contribution to a college savings plan as eligible for the $10,000 annual gift tax exclusion, despite the fact that in most cases, the donor maintains full control and can later switch beneficiaries or have the contributed amount refunded. In addition, depending on the state, each person can put $50,000 into a college savings plan for a child at one time and have it count as five years' of $10,000 gifts. Thus, appreciation of the contributed amount would not be part of the estate. (If the contributor dies within those five years, a prorated portion becomes part of the estate.)

For clients who aren't eligible for an educational IRA (i.e., if their modified adjusted gross income is over $150,000 on a joint return) or who want to contribute more than $500 each year, a college savings plan may be a consideration. Donors can make tax-free gifts to the plan for children, grandchildren, or others, but still control the contributed amount and may even take back the money if they want.

 

Because of the increasing popularity of college savings plans, CPAs need to be familiar with them. While these plans will help client's fund college expenses and the gifts to the plans may reduce estate taxes, there will still likely be an estate tax liability to handle. In addition, because the investment of contributions is directed by the state, not the donor, the client will need help in properly balancing the asset allocation imposed by the state with his or her other investments.

 

For information on the state-specific plans contact the State Treasurer's Office or these web sites: http://www.collegesavingsiowa.com/; http://www.collegesavings.org/; http://www.savingforcollege.com