Paying for College With a 529 Plan
How the Tax Relief Act Makes it Easier
Aug. 20, 2001 (SmartPros) With the cost of tuition rising at two times the rate of inflation, how to fund a college education can be a stressful decision. Education IRAs, mutual funds, savings bonds and 529 plans are just a few options from which to choose, but which is best? Thanks to a recent tax cut bill passed by Congress and signed into law by the President, 529 savings plans have quickly become a more appealing option.
On June 7, President Bush signed the 2001 Tax Relief Act that will become effective in 2002. Among other provisions, the law provides full federal income tax exemptions for 529 plans. Currently, 529 plan beneficiaries (students) are required to report withdrawals from 529 plans made for education expenses as income. The new bill provides tax relief for beneficiaries as long as the withdrawal is used for qualified college costs. The law sunsets in 2010, at which time Congress will vote whether or not to reenact it.
Named after Section 529 of the Internal Revenue Code, state-sponsored college savings plans are becoming increasingly popular. Joseph Hurley, author of "The Best Way to Save for College" and chief executive of www.savingforcollege.com, estimates that by the end of 2001, 529 savings plan assets will reach 10 billion dollars.
There are two types of 529 plans: prepaid tuition plans and college savings plans. Prepaid tuition plans allow donors to lock in current tuition rates by paying now for future education costs. The more popular option is college savings plans, which are managed by an investment firm. Some states have both, some have one or the other. A handful will enact programs this year and just two states - Georgia and South Dakota - have no legislation to implement a program.
Hurley declares that "the Education IRA, with its annual contribution cap raised from $500 to $2,000 and improved in other ways under the same bill, pales in comparison to the power of the 529 plan."
So what makes them so wonderful? The advantages of 529 plans as they stand now are numerous:
There are more advantages once the law becomes effective in 2002:
Alas, there are disadvantages to 529 plans. There is a 10 percent penalty on earnings if the money is withdrawn for non-qualified expenses. Also, once you choose an investment you have to stick with it for at least one year. Investments cannot be made in both a 529 plan and an Education IRA for the same beneficiary within the same year. And due to the new law, tax reporting for 529 plans will be more complicated come 2002.
Contact the State Treasurer's Office to review your state's 529 program.2001 SmartPros. All rights reserved. Originally published July 16, 2001