529 Plans - What, Why and What's New

What is a 529 plan? They are investment vehicles designed to help families pay for future expenses associated with college or other qualified post-secondary training. Though contributions to a 529 plan are not deductible for federal income tax purposes, these plans offer other tax advantages and are named after Section 529 of the Internal Revenue Code. All 50 states and the District of Columbia sponsor at least one type of 529 plan.

What's new in 2009? The American Recovery and Reinvestment Act of 2009 (ARRA) added computer technology to the list of college expenses (tuition, books, etc.) that can be paid for by a 529 plan. For 2009 and 2010, the law expands the definition of qualified higher education expenses to include expenses for computer technology and equipment or internet access and related services to be used by the designated beneficiary of the 529 plan while enrolled at an eligible educational institution. Software designed for sports, games or hobbies does not qualify, unless it is predominantly educational in nature.

What "computer technology or equipment" refers to. This means any computer and related peripheral equipment. Related peripheral equipment is defined as any auxiliary machine (whether on-line or off-line) which is designed to be placed under the control of the central processing unit of a computer, such as a printer. This does not include equipment of a kind used primarily for amusement or entertainment. "Computer technology" also includes computer software used for educational purposes.

Why use a 529 plan? There are advantages of 529 plans and one may be suitable for your family's needs. Earnings are not subject to federal tax when used for eligible college expenses. Earnings are often not subject to state tax. States may offer other incentives to in-state participants. There are no income restrictions on individual contributors. Contributions are only limited by the qualified education expenses of the beneficiary. You can change the beneficiary of a plan if the new beneficiary is in the same family. You can open a plan benefiting anyone: a relative, a friend or even yourself. The plan owner or custodian controls the funds until withdrawal, not the beneficiary.

How 529 plans are structured. There are two basic types of 529 plans -prepaid tuition plans and savings plans. A prepaid tuition plan enables a family to pay for future tuition now in current dollars and prices. A savings plan enables a family to accumulate funds in a tax-advantaged way for future tuition costs. A 529 plan can be established and maintained by a state, state agency, or an eligible educational institution. Each 529 plan is somewhat unique. Some state-sponsored plans offer incentives to in-state participants, such as state income-tax deductions or credits. Each 529 plan has one custodian and one beneficiary. A student or future student can be the beneficiary of more than one 529 plan.

Contribution limitations. The maximum amount that may be contributed on behalf of each designated beneficiary varies among States. Typically, contributions to each plan are limited to amounts that are necessary to finance the designated beneficiary's eligible education expenses. Where limits are established, they are usually applied on a lifetime basis. For instance, a plan may limit total contributions to $250,000, which is the maximum total that can be contributed to the designated beneficiary's 529 account over time.

Amounts contributed to a designated beneficiary's 529 account is treated as a gift. However, contributions of up to $13,000 can be made for each designated beneficiary without incurring federal gift tax in accordance with the annual exclusion applying to gifts to each donee. Alternatively; an individual may be able to contribute a lump sum that covers five years, giving a total of $65,000 ($130,000 for married couples), providing the individual makes no additional gifts to that designated beneficiary for the five-year period.

Care must be taken to ensure contributions do not exceed amounts necessary to cover eligible expenses, as the earnings portion of distributions not used to cover such expenses may be subject to income tax and early distribution penalties.

Rollovers, Transfers, Changing Designated Beneficiaries. If a designated beneficiary no longer wants or needs the balance in his/her 529 Plan, the amount can be given to an eligible family member of the beneficiary. For this purpose, eligible family members include the following:

  • the designated beneficiary's spouse
  • the designated beneficiary's son or daughter or descendant of the beneficiary's son or daughter
  • the designated beneficiary's stepson or stepdaughter
  • the designated beneficiary's brother, sister, stepbrother or stepsister
  • the designated beneficiary's father or mother, or ancestor of either parent
  • the designated beneficiary's stepfather or stepmother
  • the designated beneficiary's niece or nephew
  • the designated beneficiary's aunt or uncle
  • the spouse of any individual listed above, including the beneficiary's son-in-law, daughter-in-law, father-in-law, mother-in-law, brother-in-law or sister-in-law
  • any individual for whom the home of the designated beneficiary is his or her primary home for the entire tax year
  • the designated beneficiary's first cousin

The amount can be moved to an eligible family member as a rollover, transfer or by changing the name and tax identification number on the account to that of the new designated beneficiary. If the rollover method is used, the rollover must be completed within 60-days of the amount being distributed from the plan.

Use with other aid. A family using a 529 plan to pay for some of a child's college expenses may still be eligible to claim either the American opportunity credit or the lifetime learning credit.

You should call your EisnerAmper representative or refer to IRS Publication 950, Introduction to Estate and Gift Taxes for a general discussion of gift tax rules. For information on a special rule that applies to contributions to 529 plans, see the instructions for Form 709, United States Gift (and Generation-Skipping Transfer) Tax Return.

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