529 Plans

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A 529 Plan is a form of investment, with certain tax advantages, that is directed towards providing the recipient of the plan financial security regarding costs of attending university or college. Currently there exist two kinds of plans. One kind of 529 plan is called a prepaid plan. A prepaid 529 Plan―managed only via individual states, universities and colleges―gives the option of buying tuition monies to be used at a later date, and that are set by present day rates. So, in essence, the value of a prepaid plan is dictated by the inflation rate of tuition. At present, twelve of the fifty states offer a prepaid 529 plan. In contrast, a 529 savings plan―managed by states only―has its value dictated not by tuition rates, but the overall fluctuating value of the financial investments―mutual funds, usually―used to fund the savings plan. The majority of such savings plans provide an option to portion out investment assets according to the recipient’s age, thus, for example, the mutual fund investments grow conservative when the recipient approaches university age.

What the Funds Can be Used For

Funds from the prepaid and savings 529 Plans can be used for several university and college needs. For example, funds can be allocated towards living expenses (rent and utilities), cost of tuition, college fees, textbooks, laboratory supplies, etc. Furthermore, plan money for such expenses can be used not only at United States universities and colleges, but also certain designated higher-learning centers outside the U.S.

If any funds from a 529 plan happen to be used for purposes not listed above, income tax will be charged as well as a ten-percent fee for early withdrawal of funds. However, such charges and fees may be waived if any of the following situations apply:

  1. Death of the recipient. If this occurs, the funds are allocated to another recipient or the deceased recipient’s estate.
  2. Disability (physical or mental) of the recipient. A medical doctor must approve the recipient’s disability.
  3. The recipient obtains any of the below conditions:
    1. an educational scholarship
    2. financial-aid as a result of veterans’ status
    3. financial-aid via an employer
    4. financial-aid via gifts, trust funds, etc.

Advantages

529 Plans include several advantages. For example, deductions of income tax are provided for either a portion or the entire plan contribution. Also, the plan’s principal amount is deferred from tax, and education cost allocations are tax-exempt.

student with money

Another advantage of 529 Plans is that the donating contributor keeps sole control of the plan, with the recipient having zero control over the funds. Thus, the contributor can repossess some or all monies at any given time. However, as stated in the above section, if funds are taken out of the plan for reasons other than the prescribed educational costs, income tax will be charged as well as a ten-percent fee for early withdrawal of funds.

A further benefit of a 529 Plan is that it’s a convenient way to financially prepare for higher-learning. The donor is only required to fill out a form and then donate regular contributions to the plan, with any and all investments managed by the plan. The plans have low donation limits, with the high end of the contribution often hitting the $300,000 range. Investment fees are minimal, with an open-eligibility for the plans―zero age range and no personal income limit.

Finally, the funds in a 529 Plan are not put towards the contributors overall estate regarding taxes on his or her estate. So, a 529 plan can easily be utilized as a management tool when planning one’s estate, with the ability to shift funds out of the estate plan while maintaining control of the 529 funds for future use. Additionally, any unused portion of a 529 Plan can be simply “rolled over” to members of the recipient’s family.

Disadvantages

Regarding the disadvantages of a 529 Plan, the IRS limits only one shift of assets per year, unlike, say, a 401(k) plan. Also, not all types of investments qualify for inclusion in a 529 Plan. Furthermore, as mentioned previously, if funds are taken out of the plan for reasons other than the prescribed educational costs, income tax will be charged as well as a ten-percent fee for early withdrawal of funds. Thus, suppose a plan donation is made in the amount of $100,000, growing to $200,000 as time passes. If the donor takes funds out of the Plan for reasons other than the prescribed educational costs, the donor will be taxed on the $100,000 gain, with a further ten-percent fee on the $100,000 gain, amounting to a ten-percent fee of $10,000.