First Person: Protecting College Savings From Taxation With a 529 Plan

 

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Parents can expect a higher tax burden on the investments and income made for their children’s education in the future. Called the Kiddie Tax, any child unearned income over $1,900 becomes a part of the parent’s gross income and becomes taxable.

Parents, who have been saving for college under their child’s name, may wish to transfer those college investments into a tax safe 529 plan. When parents use the money from a 529 for college expenses all of the income that comes out of the account is tax- free. [3 pages 364-365][4 – see Tax for Certain Children Who Have Investment Income of More Than $1,900]

Tax Free Earnings

One of the most attractive features of a 529 plan is that all earnings are state and federal tax free when used for eligible 529 college expenses. State 529 programs have no income restrictions for individual contributors and plans can benefit anyone including you. The only limit being that single gifts into the account cannot exceed $13,000. Most states limit the total amount in an account to $300,000 since they consider this amount to be the reasonable expenses needed for a four-year education.

As an additional tax incentive, under The Economic Growth and Tax Relief Reconciliation Act of 2001 parents are now able to claim a HOPE tax credit or a Lifetime Learning tax credit as long as their claimed college expense do not overlap with costs paid by a 529. All 529 accounts allow the transfer of funds from other investments. Contact a financial adviser or tax professional to advise you on the initial investment limitations set by the 529 you have selected. [1][2][3 page 62,63 ]

Effects on Student Aid

As with most investments used for college the federal government does take into account the amount of money invested into a 529 plan. Depending upon the type of 529 plan selected the federal government will assess the plan’s total investment amount as a parental asset up to 5.6 percent of the amount or as a student resource which reduces aid eligibility dollar for dollar. [3 pages 57-65]

College Expenses Covered

The 2009 American Recovery and Reinvestment Act added to the list of expectable 529 college expenses to include computer equipment, internet access and other computer related products such as software. Other expenditures covered by a 529 include such things as tuition, books and student housing. [1][3 pages 548-549]

How to start

All fifty states offer some type of 529 program and many of them offer tax incentives such as income deduction for residents to use their program. Contact your state’s department of revenue or secretary of state’s office for information on their 529 program.

It is vital when selecting a 529 program that you evaluate the program’s past performance, its investment costs such as fees and startup investment policies. Most financial advisers recommended that you discuss your 529 program options with a financial professional in order to select the best program for your family.

Source: GrowingSavings.com

 

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