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Introduction
Last
spring, my cousin had a baby boy, Alexander, who was adorable
and healthy and everyone was thrilled. At the hospital, his
father announced that, by the time Alexander is ready, a college
and subsequent professional school education will cost about a
million dollars. A million dollars? I asked incredulously. The
statement sounded particularly bizarre to me. But let’s say
Alexander’s father exaggerated a bit. What if it only costs half
that projected estimate? That’s $500,000.00, and without
sophisticated planning, the goal of obtaining a professional
school education for a child in the not-so-distant future would
be beyond the reach of most families, excepting the wealthiest.
In 1996, the federal government
and all fifty states, thereafter, enacted legislation designed
to assist families in planning for their children’s educations.
The Internal Revenue Code, Section 529, provides great tax
incentives for the establishment and funding of post-secondary
school educational plans. The focus of this newsletter shall be
on these so-called “539 Plans,” the types, how they work and the
related tax-payer benefits.
529 Plans
A
529 Plan is an account that is created for a single beneficiary;
a contributor deposits cash for the benefit of another person,
the beneficiary, who need not be the contributor’s child or
grandchild. The proceeds of that account must be used
exclusively for qualified educational expenses for the
beneficiary’s post-secondary education, for example, college
and/or professional school tuition, fees, books, supplies and
room and board (room and board is subject to certain
restrictions.)
The maximum cash amount that can
be contributed varies, but in New York State the current maximum
is $235,000.00, growth on that principal is unlimited.
Types of 529 Plans
The
first type of 529 Plan is called a tuition credit plan. Under
this type of plan the contributor pre-pays tuition to an account
that is maintained by a particular school, ordinarily at a
current tuition rate. This type of arrangement is restrictive
insomuch as a grandparent who contributes to Columbia Teacher’s
College on behalf of Junior takes a chance that Junior doesn’t
want to be a teacher, or go to Columbia, for that matter.
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"Since we
were interested in creating and funding a 529 Plan for
Alexander, and we wanted the freedom to buy and sell the
equities and bonds we wanted, we created our own 529
Trust." |
A more common type of 529 Plan is
the college savings plan which was established by New York
State. Out of state readers should check with local laws.
Contributions are made to an account which is maintained solely
for the benefit of a specific beneficiary’s post-secondary
educational expenses, as outlined above. While the author makes
no representations as to which investment firm is best, Vanguard
and Fidelity are two firms that have such plans. The up-side of
choosing such an investment firm is that the individual
contributor does not have to worry about trading individual
equities or bonds, the investment firm does that, usually
through a mutual fund. The down-side of choosing such a plan
through one of the above-referenced investment firms is that the
individual contributor does not have the freedom to trade
individual equities or bonds or other investment vehicles.
For a moment, let’s return to my
particular family scenario. Since we were interested in creating
and funding a 529 Plan for Alexander, and we wanted the freedom
to buy and sell the equities and bonds we wanted, we created our
own educational trust. The nice thing about this method is that once the
trust is written, most investment firms will allow you to open a
trust account with them, and then manage that account yourself.
As a result, one is not limited to certain investment firms; you
can usually go with the one you want. It’s a good option for
those interested in managing the trust assets, personally. So
long as the original contribution is cash, this method gives the
contributor lots of options, including, but not limited to
mutual funds, equities, bonds, commodities and the like.
Tax Implications
Firstly,
529 plans accumulate income federal and New York State
income tax free. Secondly – and more importantly to the
beneficiary-student once her higher education has commenced –
distributions from 529 accounts which are used for qualified
educational expenses are not subjected to federal or New York
State income taxes. It is important to note that there may be
New York State tax penalties imposed on contributions made to
out of state plans. Non-New York State residents may be impacted
differently, so it is a good idea to check with your accountant
or attorney if you are not a New York State resident.
In addition, a New York resident
may take an annual income tax deduction of up to $5,000.00 (up
to $10,000.00 for a married couple,) subject to recapture if
that ever becomes an issue. Contributions made to a 529 Plan
which fall within the $12,000.00 annual gift tax exclusion
($24,000.00 if a married couple “splits the gift”) can result in
a nice bit of change for a child entering the NYU pre-med class
of 2030, if the contributor commences funding this year. While
there may be additional gift tax, generation skipping tax and
estate tax ramifications to contributing to a 529 Plan, those
considerations should be raised with advisors on a case by case
basis. Such ramifications are outside the scope of this article.
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