The Ins and Outs of 529 College Tuition Plans

If you would like to lower your tax bill and will be paying college tuition in the future then please keep reading…

A great way to set money aside for college is a Qualified Tuition Program also known as a 529 Plan. These state sponsored programs can be set up to benefit your kids, grandkids or anyone else who you would like to give a helping hand.

How It Works

There are two types of 529 plans:

1) Prepaid Plans – This type of plan allows you to purchase future college classes at current tuition rates. When you consider the incredible growth rate of college tuition, it’s obvious this is a good investment. However, the prepaid plans are utilized less often because the concept becomes a little difficult for the investor to grasp, especially when they begin to consider what happens if the beneficiary elects to go to an out of state college or may not go to college at all.

2) Savings Plans – This type of plan allows you to contribute funds to an account which holds investments and works very much like a retirement account. This type of plan is much more popular because of the familiarity of purchasing securities with your invested funds, however there is no guarantee that the investment performance will be able to keep pace with tuition inflation rates.

Tax Benefits

The federal and state governments take a very different approach to the tax benefits of these plans.

The federal government treats these plans very much like a Roth IRA. There’s no income tax deduction allowed on the contributions to the account, but the earnings of the account are not subject to tax as long as the distributions are used for qualifying education expenses. If the funds are distributed without being used for qualifying expenses, not only are the earnings subject to tax, but they are subject to a penalty as well.

The state governments provide an even greater tax benefit for contributing to a 529 plan. In addition to allowing earnings to be distributed tax free, the states give you a deduction for the initial contribution if you play by their rules. Generally, in order to receive a state income tax deduction you must invest in the plan sponsored by your home state (you are free to participate in another state’s program but will not get the current state income tax deduction). Also, each state caps the amount that may be deducted in a given year.

Please contact us if you are interested in discussing whether investing in a 529 plan would make sense for you. There can be very different tax results depending on how the accounts are set up and funded. We would be glad to help you understand how to maximize the amount that you can deduct in your state and how to minimize any potential gift tax implications. Please don’t hesitate to contact your MKS&H representative or call 410-296-6200 to speak to one of our tax experts.

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Article Provided By Tim Stolz, CPA, MKS&H Senior Tax Accountant

About MKS&H: McLean, Koehler, Sparks & Hammond (MKS&H) is a professional service firm with offices in Hunt Valley and Frederick. MKS&H helps owners and organizational leaders become more successful by advising them regarding their financial, technology and human capital management needs. Please visit www.MKSH.com for more information.