529 Savings Plans and Qualified Tuition Programs

By | February 1, 2014

What are 529 Plans and Qualified Tuition Programs?

Qualified tuition programs, also known as 529 plans allow prepayment of higher education costs on a tax-favored basis. These programs offered by the IRS could be very beneficial for any parent, grandparent, or other family member saving for a child’s college expenses because the 529 plans offer several tax benefits.¬†There are no income tax consequences to either the contributor to the QTP or the designated beneficiary when contributions are made and while funds remain in the account.

529 Savings Plans and Qualified Tuition Programs

  1. First, there are prepaid college savings plans, which allow you to buy tuition credits or certificates at present tuition rates, even though the beneficiary (child) won’t be starting college for some time.
  2. Second, the more common, is the 529 savings plans, which depend on the investment performance of the fund(s) you place your contributions in.

 

College Tax Benefit and College Savings Plans (529s)

People giving to one of these college savings plans will not get a federal income tax deduction for the contribution, but the earnings on the account will not be taxed while the funds are in the program. One unique feature of these college savings plans is that owners can also change the beneficiary or roll over the funds in the program to another plan for the same or a different beneficiary without income tax consequences.

This could be useful when someone wants to add children to which they are saving for college money. Normally, a distribution from a qualified tuition program isn’t subject to gift tax, but a change in beneficiary or rollover to the account of a new beneficiary may be.

 

How are Distributions from 529 Plans Taxed?

Distributions from the 529 savings program are tax-free. However, this is only true if they do not exceed the student’s qualified higher education expenses. ¬†Qualified higher education expenses include tuition, fees, books, supplies, and required equipment. Reasonable room and board is also a qualified expense if the student is enrolled at least half-time. It is absolutely essential that taxpayers save all receipts and provide evidence upon request to back up these deductions.

Distributions in excess of qualified expenses are taxed to the beneficiary to the extent that they represent earnings on the account. A 10% penalty tax will also be imposed.

Most schools are eligible for the 529 college savings plan. Eligible schools include colleges, universities, vocational schools, or other postsecondary schools eligible to participate in a student aid program of the Department of Education. This includes nearly all accredited public, nonprofit, and proprietary (for-profit) postsecondary institution.

 

529 Plans and Gift Tax

The contributions you make to the qualified tuition program are treated as gifts to the student, but the contributions qualify for the annual gift tax exclusion, which is $14,000 for 2013. If your contributions in a year exceed the exclusion amount, you can elect to take the contributions into account ratably over a five-year period starting with the year of the contributions.

With no other gifts given during the year, this means that taxpayers could contribute up to $70,000 per beneficiary in 2013 without gift tax. A married couple could contribute $140,000 for 2013 per beneficiary, subject to any contribution limits imposed by the plan.

Also, accounts are aggregated only when they are with the same state QTP and have the same account owner and the same designated beneficiary. States consider their savings and prepaid plans separately for this purpose.