College Education Plans – 529

For decades, the US government and IRS have worked hard to create ways to motivate US citizens to save for the future. In the 1970s, 401K plans were introduced to provide ways to motivate Americans to save for their retirement in lieu of relying solely on Social Security. 401K plans have allowed taxpayers to sock away pre-tax earnings into investment accounts for the future, deferring taxes until such time their 401K funds are withdrawn.

With the growing costs of getting an education in America, a similar plan to the 401K plan was introduced by Congress in 1996. The plan is called a “529 plan”, named after the IRS code to which the plan is tied. By definition, these “qualified tuition plans,” are flexible, tax-advantaged accounts. Taxpayers can invest in them with pre-tax dollars to be used specifically as educational savings.

Below, we will discuss how these plans work and what if any tax advantages they offer to the taxpayer.

Education Savings account

How Educational Savings Accounts work

While 529 plan legislation was passed at the federal level, all plans are run at the state level by authorized state institutions, universities and the state itself. Each of the 50 states and the District of Columbia offer at least one plan option. You will be happy to learn you are not restricted to selecting a plan from your state of origin or the state within which you intend to use the funds. You can in fact choose any qualified plan regardless of state of origin, making the market very competitive.

The plan accounts can be set up by yourself (contributor) in the name of any beneficiary regardless of their relationship to you. Additionally, you can set up as many plan accounts as you want, naming different beneficiaries for each account.

There are two different qualified plan options: prepaid tuition plans and education savings plans.

This option allows you to contribute an unlimited amount of your pre-tax earnings to purchase credits towards college tuition from participating colleges and universities. The monies are designated specifically for that purpose. The monies cannot be used to purchase educational materials or technology, nor can it be used to cover educational costs at lower levels (elementary school, high school).

This option allows you more flexibility. First, funds can be used to pay for a wider range of costs, including but not limited to tuition, room, board, books and technology devices. The funds can be applied towards college and university costs for qualified schools in America and in some cases, educational expenses abroad. Finally, these savings plans can be used to pay for up to $10,000 a year of lower-level educational costs, which includes public, private or religious elementary or secondary school.

While funds are accumulating in the plan accounts, you may invest said funds in approved investment fund options. This is a wonderful benefit for anyone who is intending to designate plan funds for college costs that are expected to take place well into the future. If the funds are going to be used for secondary-level educational costs, this particular benefit would not carry as much value.

As indicated above, you can use pre-tax dollars to establish and fund your tax-advantage accounts. At the federal level, the funds will always remain federal tax-exempt as long as the funds are used as set forth by IRS guidelines. Should you elect to withdraw the funds and use them for any other purpose, regardless of nature, you will be required to pay federal taxes at your own statutory tax rate, plus a penalty of 10% of the amount withdrawn.

At the state level, the terms and conditions are set forth by each individual state. In most states, they follow the same guidelines as set forth by the IRS. That means the funds remain tax-exempt as long as they are used per plan guidelines. In the states that choose to simply defer taxes until said funds are used for any purpose, you could be required to pay any applicable income taxes at the time an amount is withdrawn.

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