Thursday, June 25, 2009

A Timing Opportunity for Your 529 Plan?

Since they have been around for more than a few years, I hope that everyone knows the basics of Qualified Tuition (529) Plans. A 529 Plan is an education savings plan operated by a state or educational institution. It is designed to help families set aside funds for future college costs. Section 529 is the part of the Internal Revenue Code which created these types of savings plans way back in 1996.

Here are some basics. There is a lot of literature out there which delve into the details but let's have a little review in order to set up the thrust of this post.

Ten Key Points

1. 529 Plans can be used to meet costs of qualified colleges nationwide. In most plans, your choice of school is not affected by the state of your 529 savings plan. Every state now has at least one 529 plan available. It's up to each state to decide whether it will offer a 529 plan and what it will look like, meaning 529 plans can differ from state to state.

2. As long as the plan satisfies a few basic requirements, the federal tax law provides special tax benefits to you, the plan participant. Although your contributions are not deductible on your federal tax return, your investment grows tax-deferred, and distributions to pay for the beneficiary's college costs come out federally tax-free. The tax-free treatment was made permanent with the Pension Protection Act of 2006.

3. Your own state may offer some tax breaks as well (like an upfront deduction for your contributions or income exemption on withdrawals) in addition to the federal treatment. You should research what benefits residents receive for investing in your own state's 529 plan. If you don't get any benefits from your state, you have the pick of every 529 plan on offer.

4. You, the donor, stay in control of the account. With few exceptions, the named beneficiary has no rights to the funds. You are the one who calls the shots; you decide when withdrawals are taken and for what purpose. Most plans even allow you to reclaim the funds for yourself any time you desire, no questions asked. (However, the earnings portion of the "non-qualified" withdrawal will be subject to income tax and an additional 10% penalty tax). This level of control compares favorably to a custodial account under the Uniform Transfers to Minors Acts (UTMA).

5. The ongoing investment of your account is handled by the plan, not by you. Plan assets are professionally managed either by the state treasurer's office or by an outside investment company hired as the program manager.

6. If you want to move your investment around you may change to a different option in a 529 savings program every year (program permitting) or you may rollover your account to a different state's program provided no such rollover for your beneficiary has occurred in the prior 12 months. Hint: There is no federal limit on the frequency of these changes if you replace the account beneficiary with another qualifying family member at the same time.

7. Everyone is eligible to take advantage of a 529 plan, and the amounts you can put in are substantial (over $300,000 per beneficiary in many state plans). Generally, there are no income limitations or age restrictions.

8. 529 Savings Plans work much like a 401K or IRA by investing your contributions in mutual funds or similar investments. The plan will offer you several investment options from which to choose. Your account will go up or down in value based on the performance of the particular option you select.

9. Prepaid Plans let you pre-pay all or part of the costs of an in-state public college education. They may also be converted for use at private and out-of-state colleges. The Independent 529 Plan is a separate prepaid plan for private colleges.

10. Educational institutions can offer a 529 prepaid plan but not a 529 savings plan (the private-college Independent 529 Plan is the only institution-sponsored 529 plan thus far).

You should compare each of the Savings Plans you are considering. It would also be worthwhile to compare the 529 Plan to a Coverdell Account,to Savings Bonds, to Uniform Gift to Minor Accounts and Uniform Transfer to Minor Accounts (UGMAs/UTMAs).

The major brokers such as Fidelity all have primers on 529 Plans. Look here for example. Or here is a link to Vanguard's 529 Plan.

A Timing Idea?

So you see that a 529 plan can be a powerful tool in funding a child's education! Now here is where a lesser known provision may provide a way to power-charge your Savings Plan.

The law allows you to make a five year gifting election to the plan. The normal limit is $12,000 annually. By using the election, you can make a gift of $60,000 in one year, just so long as you forgo additional transfers for the next 5 years. If this is for your child's account and you are married, your spouse can also make this election. So in one year you could transfer $120,000 out of your estate and into a child's education account where it compounds tax free.

Why may this be a very good time to consider this? The market has just fallen 57% from its top in Fall 2007 to March 2009 bottom. Today it is still over 40% down from that top despite the recent large rally. Some experts, like the highly respected Jeremy Grantham of GMO Advisors, believe the S&P500 is priced to return 9-10% annually over the next seven years. The well regarded, late market historian Peter Bernstein said of Grantham that he was the only advisor out there who he thought may be able to accurately predict long term rates of return. See here. In Summer 2007 Grantham was warning that we were in a risk bubble where everything was overvalued. Well, 57% off changes a lot of that! See here. If you believe Jeremy Grantham (and please do your own due diligence), now may be the time to make that five year election and take advantage of what the market is now poised to give you.

If you have a medium to long time frame left for your college savings and this sounds like an something for you, please discuss this issue of timing with your financial advisor or tax professional.

No comments:

Post a Comment