529 PLANS

INTRODUCTION

 A 529 plan is a tax-advantaged investment vehicle designed to encourage saving for the future higher education expenses of a designated beneficiary.  529 plans are named after section 529 of the Internal Revenue Code.  Like IRAs and other tax-qualified investments, a prime benefit of the 529 plan is that the principal grows tax-deferred and distributions for the beneficiary’s college costs are exempt from tax.  The donor maintains control of the account.  With few exceptions, the named beneficiary has no rights to the funds.  You can reclaim the funds for yourself any time you desire, no questions asked.  However, the earnings portion of the “non-qualified” withdrawal will be subject to income tax and an additional 10% penalty tax.

 A disadvantage of 529 pans is that the earnings portion of money withdrawn from a 529 plan that is not spent on eligible college expenses will be subject to income tax and an additional 10% federal tax penalty, and the possibility of a recapture of any state tax deductions or credits taken. 

 USES FOR 529 ACCOUNT FUNDS

 Money from a 529 plan can be used for tuition, fees, books, supplies and equipment required for study at any accredited college, university or vocational school in the United States and at some foreign universities.  The money can also be used for room and board, as long as the fund beneficiary is at least a half-time student.  Off-campus housing costs are covered up to the allowance for room and board that the college includes in its cost of attendance for federal financial-aid purposes.  Qualified distributions from 529 plans are exempt from federal income tax.  Qualified education expenses do not include student loans and student loan interest.  A distribution from a 529 plan that is not used for qualified educational expenses is subject to income tax and an additional 10% early-distribution penalty on the gains portion of the fund unless certain conditions are satisfied.

 

INCOME TAX BENEFITS

 New York State taxpayers can make tax deductible contributions of up to $5,000 per year (up to $10,000 for married couples filing jointly).  In the 6.85% New York State personal income tax bracket, that could mean a state tax savings of $343 for an individual or $685 for a couple filing jointly. 

ESTATE TAX BENEFITS

 Assets in a 529 plan are not counted as part of the donor’s gross estate for estate tax purposes.  Thus 529 plans can be used as an estate planning tool to move assets outside of one’s estate while still retaining some measure of control if the money is needed in the future.  A beneficiary must be designated and the income tax savings are still only obtained if the money is eventually spent for education, though in some cases estate taxes can be reduced without spending the money on education.  Unused funds in a 529 plan can be transferred to other qualified members of the beneficiary’s family without incurring any penalty.

 GIFT TAX CONSEQUENCES

 Contributions to 529 plans are considered gifts under the federal gift tax regulations.  Any contributions in excess of $13,000 if filing single or $26,000 if filing jointly count against the life-time $5 million gift/estate tax exemption.  However, since direct tuition payments are not subject to the annual gift limitation, parents who are trying to minimize estate taxes may be better off making their annual gifts to another vehicle and then paying the tuition directly instead of through a 529 plan account. 

 INVESTMENT OPTIONS

 New York’s 529 College Savings Program currently includes two separate 529 plans.  The Direct Plan is sold directly to the public.  You may also participate in the Advisor Plan, which is sold exclusively through financial advisors and has different investment options and higher fees and expenses as well as financial advisor compensation.

 The Direct Plan offers a choice of 13 different investment options intended to help you save for qualified higher-education expenses.  Each investment option corresponds to a portfolio of investments or series of portfolios managed by Vanguard. 

 New York’s 529 College Savings Program allows accounts to be started with as little as $25.00.  Contributions can be made by check or automatic investment.  The only expense in the Direct Plan is a management fee of less than 0.5% of the value of the assets in the plan. The Advisor Plan has a minimum investment of $1,000 per account.  If an investment switch is desired, donors may change to a different option in a 529 savings program every year (program permitting) or the account may be rolled over to a different state’s program provided no such rollover for the beneficiary has occurred in the prior 12 months.  529 plans generally have a very low minimum start-up and contributions requirements.  The fees, compared with other investment vehicles, are low, although this depends on the state administering the plan.

 ASSETS AVAILABLE FOR MEDICAID PURPOSES

For purposes of determining Medicaid eligibility, funds in a 529 plan are a countable resource for the account owner. The assets are not taken into consideration in determining Medicaid eligibility for the designated beneficiary of the account. The amount of the account that is a countable resource is its value minus any penalties (e.g., a 10% federal tax penalty) for a non-qualified withdrawal. Ordinary federal, State, and local income taxes are not deductible in determining the resource value.

 IMPACT ON FINANCIAL AID

 For financial aid programs offered by the U.S. government, available balances in a 529 plan account will be treated as an asset of the student, if the student is an independent student, or of the parent if the student is a dependent.  Under New York State law, assets in a 529 account are not taken into consideration in determining the eligibility of the Beneficiary or the Account Owner for financial aid under any New York State-administered financial aid programs, such as the Tuition Assistance Program (TAP).  With respect to financial aid programs offered by educations institutions and other non-federal sources, the effect of being the owner or beneficiary of a 529 account varies.