Help A College Kid, Lower Your Taxes
'529' Accounts Come With An Array Of Tax Benefits
There are no restrictions by state residency, age or income, and a person can open a 529 plan to benefit anyone else -- whether a relative or not.
Authorized in 1996 as part of the Federal Small Business Protection Act, 529 plans -- aka Qualified State Tuition Programs (QSTPs) -- are designed to encourage parents, grandparents, godparents, friends and other relatives to save money for college through various tax incentives.
They're currently available in about half of the states in the U.S.:
- States that currently offer QSTP's are Arizona, Arkansas, California, Colorado, Connecticut, Delaware, Florida, Hawaii, Illinois, Indiana, Iowa, Kansas, Kentucky, Louisiana, Maine, Massachusetts, Minnesota, Missouri, Montana, New Hampshire, New Jersey, New York, North Carolina, North Dakota, Ohio, Oklahoma, Oregon, Rhode Island, Tennessee, Utah, Virginia, Wisconsin and Wyoming.
- States with legislation pending or plans currently in development are Alaska, Idaho, Maryland, Michigan, Mississippi, Nebraska and Pennsylvania, not to mention Washington D.C.
The Benefits Are Many
No matter what the account owner's income level is, the person may:- Qualify for deduction on their state tax returns.
- Realize earnings form the account free from state taxes.
- Watch the earnings grow with the federal tax liability deferred.
- Avoid taxes on earnings altogether if they're used for the beneficiary's college expenses -- distributions are taxed at the beneficiary's income tax rate.
Death Without Taxes
These programs are becoming heavily used by individuals with high net income individuals -- in part for estate planning purposes. The QSTP is blessed with three key benefits that make it advantageous from this perspective: Avoids Gift Taxes: The 529 plan allows contributors to exceed the normal time limits on cash gifts. Normally a grandparent may only "gift" up to $10,000 a year tax-free, paying taxes on gifts above that amount. But if the contribution goes to a 529 plan, he or she may contribute up to $50,000 in one year, free of gift taxes, and the IRS will consider it spread out over a five-year period.Avoids Estate Taxes: Second, if an account owner dies, the 529 plan balance is not considered part of his or her estate for tax purposes. A contingent account owner may be named and, ultimately, taxes will be levied on distributions to the beneficiary.
Doesn't Reduce "Unified Tax Credits:"Under current federal tax guidelines, U.S. citizens and residents are allowed to transfer up to $675,000 in assets to a beneficiary without paying estate tax, gift tax or other federal taxes. This is called the "unified tax credit." For contribution-minded grandparents whose assets exceed the $675,000 unified tax credit, the 529 is ideal. According to Dan Mainzer of the accounting firm of Canby, Maloney & Company in Massachusetts, "Grandparents may contribute a combined $100,000 into each grandchild's college savings account today without using up part of their unified credit."
Doesn't Hinder Financial Aid: An additional benefit is that, if the grandparents control the account, the investment does not count as an asset of either the student or parents when applying for financial aid.
Lower Taxes, More For Tuition
Mainzer observes that the benefits of a 529 are significant: tax-deferred growth plus taxation at the beneficiary's rate, which is typically lower: "It would not be unreasonable to expect the tax benefits to result in twice as much money available than if the same contributions were made to an account currently taxable at the parent's rate."For a grandparent seeking a way to shelter inheritance money from estate taxes, the 529 makes it possible to contribute substantial amounts to the student's college fund and watch it grow tax-deferred. The beauty is knowing that neither you nor your estate will likely ever get hit with the subsequent tax bill.
