Top 5 Reasons to Open a 529 Plan
1. Save to invest in your child’s future
2. Earnings grow on a tax-deferred basis and qualified withdrawals are free from federal income taxes1
3. Account is excluded from the contributor’s estate
4. Can be transferred to another family member if the child does not go to college
5. Gift taxes avoided for contributions up to $55,000

In fifteen years, the average cost of a public college education is projected to be $8,080 per year or about $32,000 for all four years. A private college is projected to cost $54,785 per year or about $219,000 for all four years.* Startling numbers, yes. And, if little Johnny or Suzy is to be able to afford the college of his or her choice, having the funds to pay this bill is an important goal that parents – and grandparents – should start planning for as soon as possible. There is good news for those among us who realize this.

Many states offer tax-advantaged college savings programs. These programs are tax-deferred, meaning that no tax is due prior to a distribution. Distributions from 529 plans may be fully excludable from gross income if the funds are used to pay qualified higher education expenses.1 You can also add additional monies to these as time goes on. These plans are known as 529 plans, named for part of the tax code. While 529 college savings plans are state sponsored, they are not guaranteed by the state or any other state or federal governmental agency. Therefore, investments in such plans can lose value.

The first type is the state-sponsored qualified tuition program. These are very flexible savings plans that allow for very small (as low as $25) or very large (up to $55,000 per donor, per beneficiary) contributions that can be made all at once or on a monthly basis. The state invests these contributions for your child, again, on a tax-advantaged basis.

The contributions may be “revocable” - meaning the money can be taken back: You keep control of the account, so Johnny doesn’t get to buy a car with this money. (Unlike the irrevocable custodial account.)

The second type of state-sponsored plan is called “pre-paid tuition.” Generally, these plans allow you to pre-pay tuition for a state college in your state. This is a great opportunity because you lock in tomorrow’s tuition at today’s rate, so the “college inflation rate” that I talked about earlier is not a concern.

What if Suzy decides not to go to college in your state - or at all? That depends on how your state has set up the plan - rules vary in each of the states pre-paid tuition plans are offered in. Most likely, in each case, there will be a tax penalty for early withdrawal.

529 plans have become a popular way for grandparents to give money to grandchildren. Federal law allows people to give up to $11,000 per year to each of an unlimited number of people without triggering gift tax. Section 529 goes a step better, allowing five years' worth of gifts - $55,000 - to be made at one time to each beneficiary, and then taken into account over a five-year period.

What happens if Johnny doesn’t want to go to college? One of two things; the money can be transferred to his relative’s 529 account or the money can be withdrawn. The latter could bring about a tax penalty.

Anyone - parent, grandparent, relatives, or friends - can contribute to both these plans. So, if someone asks you what kind of birthday present they can get for your child, tell them a contribution to your child’s education savings would be ideal!

Talk to your financial planner about how you and your child may be able to benefit from a 529 plan. The availability and rules of these plans vary by the states that offer them, so do check with your tax professional when considering this option. Your state’s higher education commission can also let you know if such a plan is available in your state and of any applicable rules. Additionally, you should always see if your state's plan offers additional tax benefits to its citizens.

1This exclusion from federal gross income applies to distributions from state-sponsored qualified tuition programs for tax years after December 31, 2001. The exclusion applies to pre-paid tuition plans sponsored by eligible educational institutions for distributions made in tax years after December 31, 2003. These exclusions will expire December 31, 2010, at which time the taxation of the distribution will revert back to the tax treatment prior to adoption of the Economic Growth and Tax Relief Reconciliation Act of 2001.
*The College Board, 2003

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