From Living Well Magazine
What is a 529 Plan?
A “529 Plan” refers to the section of the Internal Revenue Code that permits a tax-advantaged method to invest for a child, grandchild, or other beneficiary’s college expenses. There are two types of 529 Plans, (i) a tuition credit plan and a (ii) cash savings plan.
- Tuition Credit Plan – With the tuition credit plan, pre-paid tuition credits are purchased either from a specific college or from a tuition credit plan composed of a group of colleges. The credits can subsequently be utilized to pay the beneficiary’s tuition at the college or a college that participates in the plan.
- Cash Savings Plan – The Cash Savings Plan is more frequently discussed and utilized. With these plans cash is contributed to a 529 investment account that can subsequently be used by the beneficiary to attend any qualified post-secondary educational institution.
What is the Tax-Advantage of a 529 Plan?
Although a federal income tax deduction is not permitted for contributions to the plan, (i) the earnings on the 529 Plan account are NOT subject to income tax, and (ii) to the extent distributions are utilized for a “qualified higher education expense,” the distributions (including the growth) are free from the federal income tax. Thus, the earnings on the account escape taxation if used for a permitted purpose.
In addition, Missouri allows an income tax deduction for Missouri residents up to a maximum of $8,000 per taxpayer for contributions to Missouri’s 529 Plan, and it does not tax the earnings on the account if utilized for a qualified purposes.
What is a “Qualified Higher Education Expense” and what is a “Qualified Post-Secondary Educational Institution?”
- Qualified Higher Education Expense – Tuition, fees, books, supplies, required equipment, and room & board (subject to certain limitations) at a Qualified Post-Secondary Educational Institution.
- Qualified Post-Secondary Educational Institution – An accredited post-secondary educational institution offering credit towards a degree and certain vocational schools.
What happens if the distribution is NOT used for a “qualified higher education expense?”
The earnings portion of the non-qualified distribution are included in the recipient’s income and are subject to a 10% penalty tax.
What if the beneficiary does not go to college?
The owner of the account can (i) change the beneficiary of the account, (ii) withdraw the funds and pay the tax and 10% penalty on the earnings, or (iii) retain the account for future use by the existing beneficiary. Note, there may be gift and generation skipping tax issues if the beneficiary is changed.
Is the 529 Account included in the Account Owner’s estate at death?
No, this is one of the unusual things about 529 Plans. Even though the account owner maintains control of the account, including the ability to change the beneficiary and name a successor account owner, the account is not included in the owner’s estate at death (subject to the exception noted in paragraph seven).
Are contributions to 529 Plans subject to the Gift Tax or the Generation Skipping Tax?
A contribution is treated as a taxable gift by the donor to the extent it is in excess of the donor’s remaining annual exclusion ($13,000 for 2012) for the calendar year for that beneficiary. The transfer also may be subject to the generation skipping transfer tax if the beneficiary is a grandchild or other “skip person.” However, there is a special rule that permits the donor to make a “five-year forward election” in the year of the contribution and recognize the transfer in excess of the annual exclusion ratably over the succeeding four years. If the account owner dies during the five years, the amount of the gift that has not been recognized is included in the account owner’s gross estate.
Is there a limit on the amount that can be contributed to a 529 Plan?
Yes, the federal law requires that each state set limits on the amount that can be contributed to a beneficiary’s account or accounts, as the purpose of the favorable tax treatment is for college savings, not retirement or other investment savings. In Missouri, the maximum contribution limit is $235,000, but earnings may accrue on that amount.
If the donor is a resident of Missouri, are they only permitted to contribute to Missouri’s 529 Plan?
No, a Missouri resident can contribute to any state’s 529 Plan, but the Missouri $8,000 income tax deduction is only permitted for contributions to Missouri’s plan. In addition, Missouri has recently established a Matching Grant fund of up to $500 for qualified donors and beneficiaries of a Missouri account.
Why would a Missouri resident choose to invest in another state’s plan?
Again, each state establishes its own 529 Plan pursuant to the rules of the federal law permitting the plans. One requirement is that the state must provide the investment options among which the account owner can invest. What this means is that each state has different investment managers and investment options. For example, VanGuard is the investment manager for the MOST plan, and while there are numerous investment alternatives (currently 17) a donor may prefer the investment manager or investment options of another state’s plan.
In summary, 529 Plans provide an income tax effective method for parents, grandparents and other relatives or donors to contribute and save for a beneficiary’s higher education expenses. However, there can be other gift, estate tax, or even financial aid implications to the donor and/or beneficiary. Consultation with a tax advisor is recommended to ensure a 529 Plan is the most effective method for the donor and/or beneficiary and to ensure the contribution in made in the most effective manner.
Jennifer K. Huckfeldt is a shareholder in the law firm of Carnahan Evans Cantwell & Brown, PC. She received her law degree from the University of Missouri – Columbia in 1991, her LL.M. in Taxation from New York University School of Law in 1992, and she was elected as a fellow of the American College of Trust and Estate Counsel in 2011. Ms. Huckfeldt has nearly 20 years of experience in estate and gift tax planning and is a frequent lecturer and writer for the Missouri Bar. She concentrates her practice in the areas of estate, gift and fiduciary income taxation, planning with retirement benefits, and post-death trust administration and taxation matters. You may reach Ms. Huckfeldt at 417-447-4400.