Tuesday, July 21, 2009

Are 529 Plans the Best Way to Save for College?

529 plans are great college savings tools because, although contributions are not deductible on a federal tax return, earnings withdrawn to pay for qualified higher education expenses such as tuition, books, and room and board are tax-free. The definition of "qualified higher education expenses" was expanded to include computers for 2009 and 2010.

Although contributions to a Utah 529 plan are not deductible on a federal income tax return, the State of Utah will allow the contributor to claim a 5 percent tax credit on up to $3,480 per beneficiary if the contributor is married filing jointly. A tax credit is a dollar-per-dollar reduction of a tax liability, and is thus more valuable than a tax deduction. Consequently, the state will pay as much as $174 of State income tax liability for a 529 contributor who is married filing jointly.

529 plans can be setup for any beneficiary, including your child, grandchild, spouse, neighbor, friend, or yourself. Additionally, the person who contributed the funds can change the beneficiary of the account at any time. Thus, if your beneficiary decides not to attend college, another beneficiary can be named so the tax-free benefit of the account is maintained. Further, the funds can be used at almost every school across the country.

The last advantage of 529 plans is derived from the plan's contribution limits. In 2009, an individual can contribute up to $13,000 per beneficiary. An individual can make a contribution to an unlimited number of beneficiaries, and an unlimited number of individuals can contribute to the same beneficiary. Even more advantageous, an individual can contribute five years-worth of funds in any given year, as long as the combined five year contribution limit is not breached. For instance, an individual could contribute $65,000 to a plan in year one, but would then be prevented from contributing to the plan during years two through five.

A drawback of the 529 savings plan is that if the funds are withdrawn for a purpose other than higher education, all growth will be taxable as ordinary income AND will be hit with an additional 10% penalty. However, if the beneficiary is awarded a scholarship, an amount equal to the tuition covered can be withdrawn from the 529 plan free of the 10% penalty, although taxes would still apply.

Speak to an independent fee only financial advisor for more information about which 529 plan is appropriate for your needs.

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