Tax Attic June 27, 2013

Jerry Coon

Jerry Coon

Last week, I discussed financing the cost of college education through the Direct Loan program. Another manner of paying for the cost of education is through the usage of Section 529 College Savings Tuition Plans. There is no question that 529 plans, if sufficiently funded, can be used to pay for almost all of the costs associated with education. So, what exactly is a Section 529 College Savings Tuition Plan? The strict answer is it is a tuition savings plan created by Congress in 1996, named after Section 529 of the Internal Revenue Code, which allows a taxpayer to put aside money that can pay for the qualified education expenses of a designated beneficiary. How much money can be contributed to a 529? All 50 states and Washington D.C sponsor 529’s. Each state has its’ own contribution limit. It is not unusual to be able to contribute to the plan until there is a total of over $350,000 in the plan. Up to $70,000 can be contributed to the plan in any one year. This is the gift tax yearly limit of $14,000 times five years. A gift tax return, however, does have to be filed in the first year of contribution and in each of the next four years if additional gifts are made to the same beneficiary.

What are the advantages of a 529? There are multiple advantages of 529s. First, the contributions accumulate tax-deferred and become tax-free as long as the distributions are used to pay eligible college expenses. Second, the owner of the 529 has the ability to change the beneficiary by naming a new beneficiary or by rolling the 529 proceeds into a new account with a new named beneficiary. Third, a 529 plan can be set up in a high contribution limit state such as Florida, with a maximum of $418,000, to take advantage of putting more money into the plan even though the taxpayer lives in a low contribution state such as we do here in Michigan which has a maximum of $235,000. Fourth, there are no age limits for the owner or the beneficiary and the owner can be the beneficiary. Fifth, there are no income limits for the owner or the beneficiary that could phase-out the contribution amounts. Finally, there are estate considerations. Should the owner pass away, the 529 is generally not counted as part of the owner’s estate.

Let’s expand on those six advantages. First, eligible college expenses include tuition, fees, books, supplies, room and board, and computer, software, and internet services used by the student for required course-work. If a student doesn’t live on campus, most colleges will provide the appropriate room and board figure that the beneficiary may then withdraw from the 529. As long as eligible expenses are paid, the earnings are tax and penalty free. The penalty is 10% on the earnings if the expenses paid are not eligible. In addition, the earnings are taxable.

Second, a new beneficiary can be named but that new beneficiary must be a member of the previous beneficiary’s family. If the original beneficiary is your grandchild, the new beneficiary must be related to your grandchild, including a cousin of that grandchild. A new beneficiary can only be named once per year. If a non-eligible beneficiary is named or a new one is named more than once in a year, the built-up earnings may be taxable and the 10% penalty may apply.

Third, in an effort to even the playing field, some of the low contribution states, such as Michigan, allow the contributions made to the home-state plan to be deducted on the state return. Up to $10,000 can be deducted on the MI-1040 by a resident of Michigan who makes a $10,000 contribution to a Michigan plan. If the Michigan resident makes a $10,000 contribution to a Florida plan, there is no subtraction allowable.

Fourth, age is not a factor in making contributions to the plan. However, the younger the beneficiary is when the contribution is made, the longer the money will stay in the plan before it is withdrawn to pay college expenses. The longer the money is in the plan, the higher will be the earnings that can be withdrawn tax-free. That may be the biggest benefit of the plan. By putting a large amount of money into a plan when a child is very young, it can grow tax-deferred and can be withdrawn tax-free years later. Fifth, the income phase-out limits are non-existent for 529 plans. The contributions are not deductible, of course. At no point of maximum income, however, is the taxpayer not able to make the non-deductible contributions. There are no phase-outs to limit the contribution amount.

Sixth, any taxpayer of any age can contribute to a 529 plan in the amount of $70,000. Any taxpayer’s spouse can also make a contribution of another $70,000. That is a total of $140,000 to a particular beneficiary. If the taxpayer and spouse have two beneficiaries, for example, that is another $140,000 for a total of $280,000 that can be removed from the taxpayer and spouse’s estate.

Of course, I am a tax professional and I tend to leave estate planning to the estate planning attorneys. There may be an opportunity, however, to do some estate planning through the use of the 529 plans. There are advantages available through the use of 529 plans. It might pay to do some investigation to see if a 529 is right for you. This is Jerry Coon signing off.

 

Jerry Coon is an Enrolled Agent and

a Registered Tax Return Preparer.

He owns Action Tax Service on

Northland Dr. in Rockford.

Contact Jerry through his website:

www.actiontaxservice.com

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