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The following article has been excerpted from The 529 College Savings Plan Made Simple By: Richard A Feigenbaum, Attorney at Law, and David J. Morton, Attorney at Law

FREQUENTLY ASKED QUESTIONS

1. What is a 529 College Savings Plan?

A 529 College Savings Plan is a savings plan established and maintained by a state to assist families who are saving for college expenses. These plans are created under federal law and allow for tax-deferred growth on the investments, as well as federal (and sometimes state) income tax-free withdrawal from the account if the assets are used for qualified higher education expenses.

2. How do I open a College Savings Plan account?

Almost every state has a plan either in place or under development. The plan can be accessed via the Internet, or by contacting the state treasurer’s office or the financial services firm retained by the state to administer the plan. See the Appendix for state websites that contain addresses, phone numbers, and additional information.

3. What are the benefits of a College Savings Plan?

The College Savings Plan allows for assets to be professionally managed, to appreciate income tax deferred, and provide income tax-free withdrawals if they are used for qualified higher education expenses.

4. Are there income limits or thresholds that phase out or eliminate the ability to contribute to a College Savings Plan account?

No. There are no income or other limits on the ability to contribute to an account other than the maximum funding level that each state designates for its particular plan.

5. Who can establish a College Savings Plan?

Any person can create a College Savings Plan for any other person or for the benefit of themselves. As long as the assets are withdrawn for use for qualified higher education expenses, the growth on the investments will be federally income tax-free. This creates an opportunity for people to begin saving for possible graduate school or professional school later on in life, and not only for their children’s higher education expenses.

6. Once the College Savings Plan account is opened and the beneficiary is named, can we change the beneficiary?

The College Savings Plan account allows for the change of beneficiary at any time by the account owner. Certain beneficiary changes are income-tax free, while other changes result in income taxation and a possible penalty tax. Care must be taken in making beneficiary changes.

7. Can the owner of a College Savings Plan account close the account and take back all of the money?

Yes. The owner of a College Savings Plan account can withdraw all of the funds in an account at any time. However, this will lead to income taxation on the earnings on the account, as well as a 10% penalty for withdrawing the funds and not using them for qualified higher education expenses.

8. Who is allowed to be a beneficiary?

Any person can be a beneficiary, whether it is a related person (such as a child, grandchild, or spouse) or someone who is not related. The beneficiary must be a US citizen or a resident alien. You can also establish the account for yourself as the beneficiary.

9. Once an account is established, who has control over the investment decisions?

Each Plan Manager develops a number of model portfolios in which you can choose to invest your savings. Federal law requires that the consumer have no control over investment choices. As such, Plan Managers have provided a large number of options for the consumer to select from.

10. Can anyone contribute to a 529 account maintained for a beneficiary?

Each state’s plan is slightly different. However, as a general rule, most 529 plans allow for any person to make contributions into an existing 529 account.

11. What are the most common investment options given by Plan Managers?

A common investment offering is the age-based allocation investments, which are geared towards your child’s age and the year in which he or she will attend college. There are also asset allocation investments, growth investments, aggressive and conservative investments, as well as a variety of equity and fixed income options within most plans.

12. Can you change investment options once they have been selected for the College Savings Plan account?

The investment option chosen for a College Savings Plan account can only be changed once every twelve months. However, each time a new contribution is made to a College Savings Plan account, a different election can be made with respect to how these newly contributed assets are to be invested.

13. Is there a federal deduction for contributing to a College Savings Plan?

No. At the present time, there is no federal deduction for contributions to a College Savings Plan.

14. Are there state deductions for contributions to a College Savings Plan?

Yes. Many states have laws allowing for a full or partial deduction on personal income tax returns for contributions made to College Savings Plans.

15. Are the withdrawals from a College Savings Plan free from federal income tax?

A withdrawal from a College Savings Plan is free of federal income tax if the proceeds are used for qualified higher education expenses at an accredited institution. Generally, these schools are accredited if they participate in the Federal Student Aid Program. You can contact the Plan Manager for the state in which the school is located or contact the school directly to determine whether they meet this standard.

16. Are withdrawals for College Savings Plans free from state income tax?

Withdrawals from a College Savings Plan may be taxed to you depending on your state of residency. Many states have adopted the same tax rule as under federal law and exclude these plan proceeds from income tax. As such, these states will not tax distributions. Other states do not have their own income tax, and again, they would not be taxing distributions. Still other states have state income taxes and have not adopted federal law, in which case these states will tax distributions from a College Savings Plan account.

17. Can the College Savings Plan assets be used for all colleges and universities?

The College Savings Plan assets can be used for most accredited institutions of higher education in the United States. Generally, those schools— whether college, graduate, vocational, or trade school—that participate in the Federal Student Aid Program are eligible for participation in the College Savings Plan.

18. How do you change the beneficiary on a College Savings Plan account?

Each Plan Manager will maintain their own forms for purposes of updating beneficiaries on accounts. A change of beneficiary form can be completed to reflect a new beneficiary.

19. Does the changing of a beneficiary generate an income tax?

The relationship of the new beneficiary to the old beneficiary may determine whether there is an income tax, penalty tax, or gift tax on the change of beneficiary.

20. Can I borrow money from the plan or use the plan as security for a loan?

No. Federal law specifically states that you cannot use the account as collateral for a loan or borrow money from the plan.

21. What happens if money is withdrawn from the plan and not used for qualified higher education expenses?

When assets are withdrawn from the plan and not used for qualified higher education expenses, an income tax (federal and state) must be paid by the owner. He or she must also pay a 10% federal penalty on the income.

22. Who will own my account if I pass away before the account is fully utilized?

Under the existing ownership rules, an account owner has the ability to name a successor owner on the account. If no successor owner is named, then the owner’s Last Will and Testament will determine who the new owner will be.

23. How does the College Savings Plan affect qualification for financial aid?

Under existing rules, a College Savings Plan account will be treated as an asset of the owner and not an asset of the beneficiary. For this reason, care should be given to structuring ownership of the College Savings Plan account to be certain it minimizes its impact on obtaining financial aid.

24. What are Upromise and BabyMint, and how do they relate to a College Savings Plan?

Upromise and BabyMint are membership programs that offer free contributions from corporations with whom consumers do business. Upromise is also a 529 Plan Program Manager. These corporations provide contributions to a College Savings Plan account of a participant who purchases their goods.

25. Are College Savings Plan accounts taxed to the owner if the owner should die?

The College Savings Plan account is not taxed to the owner should the owner pass away while retaining control of it, unless the owner had made a large gift and was prorating the annual gift tax exclusion over a number of years, and died during that term of years.

26. Can the College Savings Plan account be obtained through an employer and be deducted from payroll?

Yes. College Savings Plan accounts are becoming a popular voluntary corporate benefit. It affords the employee the same College Savings Plan opportunity at a lower cost and allows for the use of payroll deduction. Much like the popularity of the 401(k) benefit, a College Savings Plan that is obtained through an employer is more likely to be used by the employee than if they had to secure such an account on their own. The College Savings Plan, as a voluntary employee benefit that utilizes payroll deduction, enhances the likelihood that people will save on a periodic basis for college expenses.

27. What happens if the beneficiary of a College Savings Plan account chooses not to go to college?

A College Savings Plan allows for the owner of the account to change the beneficiary of the account at any time. Making this change is as simple as signing a change of beneficiary form with the Plan Manager. Depending on the blood relationship of the original beneficiary to the new beneficiary, the change of beneficiary may be a tax-free change. In some circumstances, if the new beneficiary is not a member of the family of the old beneficiary, then the owner may be subject to income taxes and a penalty tax.

28. Must I use the College Savings Plan for the state in which I reside or my beneficiary resides?

There is no requirement that you must use the College Savings Plan offered by your home state (or the home state of you beneficiary). However, there may be income tax reasons for using your home state plan rather than a plan offered by another state. These tax reasons can include some form of possible income tax deduction at the time of contribution, or state tax-free withdrawal at the time funds are used for qualifying higher education expenses. Some states have taken steps to impose an income tax on funds withdrawn from a College Savings Plan maintained with a state other than your home state even if the funds are used for qualifying higher education expenses as a way to encourage you to use your home state’s plan.

29. Does the College Savings Plan sunset at the end of 2010?

Yes. Under current federal tax law, the College Savings Plan is scheduled to sunset (come to an end) on December 31, 2010. By the very nature of the sunset law, Code Section 529 will cease to exist after that date and these College Savings Plans will no longer be given favorable tax benefits on earnings. This may result in these accounts being subjected to income tax and possibly the penalty tax. However, commentators have discussed this issue at length and generally concur that it is unlikely that the sunset provision will be left in place.

30. Can I establish a College Savings Plan for myself and/or my spouse?

Depending on your state’s plan, you may be able to establish a College Savings Plan account for yourself or your spouse. If you or your spouse decide to go to college, those funds can be used for education expenses. You can also begin saving for a child who has not yet been born, in an effort to begin the tax deferred savings afforded by the College Savings Plan. In addition, funding an account for yourself in anticipation of a grandchild as a wealth transfer tool may be a reasonable estate planning opportunity.

31. Can a person be a beneficiary of more than one College Savings Plan?

Yes. A person can be beneficiary of as many College Savings Plans as he or she likes. Each state’s plan mandates a maximum funding level. However, there is no requirement that all of a particular beneficiary’s plans be in one state.

32. Can one beneficiary have College Savings Plans in more than one state and fund each plan to its maximum level?

Yes. Under existing law, there is no prohibition against funding as many College Savings Plans as you would like to the maximum level for the beneficiary. However, this tactic is likely to raise scrutiny from the IRS and may be treated as tax evasion—not an appropriate College Savings technique.

33. If the owner of a College Savings Plan account needs nursing home care, will the College Savings Plan account be lost to the nursing home expense?

The simple answer is that there is no clear answer yet. Once a gift is made into a College Savings Account, the money in the account should no longer be available for the owner’s debts and expenses. Unfortunately, the issue of whether money in a College Savings Plan account can be lost to the owners’ nursing home expenses is based on state law. Each state has its own rules as to what assets will be available for nursing home expenses.

34. What happens if a state does not renew its contract with a Plan Manager?

Each Plan Manager has a contract with the host state to provide 529 product services. These contracts can be of any length, but are typically five years or more. As these contracts come up for renewal, some states will elect to make changes, thereby impacting the 529 Plan investments. In some cases, the existing Plan Manager will be allowed to retain the plan assets for some period of time. In other circumstances, the investments in the Plan Manager’s 529 offerings will be transferred into the new Plan Manager’s similar type of offerings. This raises concerns for the consumer who specifically selected a plan based upon its Plan Manager. In circumstances where a program manager is replaced, the consumer will be left with the choice of staying with the state’s program with a new Plan Manager, or in the alternative, rollover the plan assets to another state where their preferred Plan Manager has a program. Caution must be exercised though, as the rollover to another state’s plan may be treated as a taxable event in your home state. It may also cause the recapture of a state income tax deduction that was granted at the time of contribution to the account.

35. Does it make sense to have more than one 529 Plan account for the same beneficiary?

There are times when it does make sense to have several accounts for one beneficiary. The most notable reason is to maximize possible state income tax deductions. For instance, if you reside in a state that gives a limited benefit for contributions to the state’s plan, you may wish to contribute the amount necessary to fully use the income tax deduction to the state plan. You may wish to invest the balance of your college savings into a different 529 Plan that might have more preferable investment options or better performance, fees, and expenses.

36. Is there a difference between a 529 Plan purchased through an advisor and a 529 Plan that is purchased directly from the Program Manager or the sponsoring state?

The only difference between plans sold through an advisor and those purchased directly is the level of advice that you will receive. The cost of the advice from a financial advisor is the load fee of such plans. The benefit of the advisor is that you will have someone to help you select the 529 Plan best suited for your family, considering all factors (such as years remaining until college, state income tax benefits, risk tolerance). Some states only offer plans through a financial advisor and some offer only direct sold plans, while other states offer both advisor and direct sold plans.

37. Can I close an existing custodial account for a child (UGMA/UTMA accounts) and use the assets to open a 529 Plan?

Yes, custodial accounts can be changed into 529 Plan accounts. The 529 Plan must be a custodial type of plan so that the child (as represented by the custodian) remains the rightful owner of the account. You cannot take custodial account assets and use them to open a 529 Plan that does not reflect the custodial nature of the account.

38. To move assets from a custodial account to a 529 Plan, must the custodial account assets be sold?

To transfer an existing custodial account into a 529 Plan custodial account, you must first sell all of the assets in the custodial account. Plans can only receive cash, so all custodial account investments must be liquidated. This may result in an income tax or capital gains tax on the custodial account assets.

39. Does a gift into a 529 Plan account incur a gift tax?

Special gift tax rules allow for an individual to make a tax free gift into a 529 Plan of $11,000 per person, per year ($22,000 for married couples) to as many people as they like. You can even accelerate these gifts by making five years’ worth of gifts ($55,000 per person, or $110,000 for married couple) all at once.

40. Should I open and maintain one College Savings Plan for all of my children (or other beneficiaries), or should I open a separate account for each child?

It is possible to open and maintain one College Savings Plan account for all children/beneficiaries you may have, although only one person can be named as beneficiary of the College Savings Plan at one time. If you have only one account for multiple beneficiaries, then you will need to be certain that after the first person uses funds for college, the name of the beneficiary is changed to the next beneficiary who will use funds for college. It is often preferable to have separate accounts for each beneficiary as a way to ensure that investments in the account are properly tailored for each individual’s age, as well as to provide a separate account for family members and friends to make gifts to.

Published in : , Paying for College

Keywords : College Money and Financial Aid, Paying for College, 529 College Savings Plan, College SAvings, College Money, Financial Aid, Scholarships

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