Kevin J. McPherson, The Daily Record Newswire
Saving for college in the best of times is difficult enough, but doing so in the current economic climate has made it even more challenging. According to College Board, tuition and fees at private and public universities have increased at an average annual rate of 2.6 percent and 6.1 percent, respectively, over the rate of inflation during the last 10 years.
During this same period, average incomes for middle-income families have remained relatively stagnant. If this trend continues, the cost of attending college is going to consume a greater percentage of the family budget with each passing year.
Many savings plans and tax incentives exist to help students and parents pay for the four years of college that could easily exceed six figures. For those that are a few years away from attending college, Section 529 Plans are a popular tool to help lessen this financial burden. These plans are typically categorized as savings plans or prepaid plans.
The 529 Savings Plans function similarly to Roth IRA and Roth 401(k) plans. Contributions are invested in mutual funds or similar investment options and grow tax free if used to pay for qualifying expenses such as tuition, books, supplies, and room and board. While you do not receive any federal tax deduction for your contribution, some states do allow such a deduction. Contributions to a New York state plan are deductible, up to $5,000 if filing single and $10,000 if married and filing jointly.
Contributions to these plans are considered gifts to the beneficiary for gift tax purposes. However, these contributions qualify for the $13,000 annual gift tax exclusion. If you make contributions greater than $13,000 in one year, an election can be made to spread these contributions over five years. This essentially allows for contributions of up to $65,000 in any one year to be made with no gift tax consequence, assuming no other gifts are made to the same beneficiary during the same five-year period.
Once these contributions are made, the asset leaves your estate but does not leave your control. The beneficiary of the account has no legal rights to the funds. The donor dictates when the funds can be distributed and for what purpose. However, if the funds are not used to cover qualifying expenses, the earnings on the contributions are subject to ordinary income tax and an additional 10 percent penalty. So for those that are being advised to reduce their estate through gifting, but are apprehensive about losing control of these assets, this is an option that should be considered.
Contrary to popular belief, 529 Savings Plans can be used to pay for most college expenses at any qualifying institution nationwide. You are not restricted to attending a university located within the state that operates your 529 Savings Plan. And if the beneficiary decides not to attend college, your contributions are not lost as you can name another member in your family as beneficiary or rollover the funds into another family member’s 529 Plan.
If these are not valid options, the donor can withdraw these funds; however, the earnings on these contributions would be taxed and subject to an additional 10 percent penalty.
The other type of 529 Plan is a Prepaid Plan. These plans enjoy many of the same benefits as the 529 Savings Plans. The Prepaid Plans are operated by numerous states nationwide and are used to cover in-state, public college education expenses. Your investment buys a given number of tuition credits at today’s prices. So in theory, by contributing to a prepaid plan today, you have locked in the cost of your public education at today’s rates. This plan is designed to protect the investor from increases in tuition costs as well as a downturn in the financial markets.
However, before investing in Prepaid Plans, you may want to read the fine print. According to Savingforcollege.com, many of these Plans do not disclose how current tuition credit pricing compares to current tuition rates. In some cases, states are charging a significant premium, making an investment in these plans less attractive.
Further, many states are no longer accepting new investors into these Prepaid Plans as many have become significantly underfunded. While these plans were designed to lessen the risk for investors, few state Prepaid Plans are actually guaranteed by the state.
A Private College 529 Plan is the only prepaid plan for private colleges. This 529 Plan allows you to purchase tomorrow’s tuition at today’s prices for enrollment at any private school in the plan’s national network of colleges and universities. This plan is sponsored by the Tuition Plan Consortium, a nonprofit group with 270 private colleges nationwide as members.
Your tuition certificates retain their value for 30 years from the date of purchase regardless of the increase in tuition or decrease in the financial markets. While these certificates are not guaranteed by a state, member colleges and universities do guarantee your tuition at the pre-purchased rate for these 30 years.
When contributing to the Private College 529 Plan, you do not have to choose a specific school, rather the prepaid tuition certificates can be redeemed at any current or future participating school.
If your child decides not to attend any of the member schools, there are provisions similar to the 529 Savings Plan and state sponsored Prepaid Plan that allow you to designate a different beneficiary, rollover the account into another 529 Plan, or obtain a refund. However, before deciding to choose this plan, make sure you fully understand these options.
529 Plans are one of many valuable tools to help save for college, but before jumping in, make sure you do your homework to ensure that the type of 529 Plan you select is the right one for you.
—————
Kevin J. McPherson, CPA, is a principal with Mengel, Metzger, Barr & Co. LLP. He can be reached at (585) 423-1860 or Kmcpherson@mmb-co.com.
