Friday, December 5, 2008

The Best Christmas Ever! pt. 2

Utah 529 College Savings Plans

Utah offers one of the most attractive 529 plans in the country. Like all 529 plans, contributions to a Utah 529 plan are not deductible on a federal income tax return. However, the State of Utah will allow the contributor to claim a 5 percent tax credit on up to $1,650 per beneficiary if the contributor is single, or $3,300 if the contributor is married filling 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 $82.50 of a single contributor's State tax liability, and as much as $165 of State tax liability for a contributor who is married filling jointly. Additionally, the Utah 529 plan offers a range of diversified options from Vanguard, which can be purchased without a sales charge and are inexpensive to own.

529 plans are a great savings tool because, although contributions are not deductible on a federal tax return, earnings withdrawn from the plan to pay for qualified higher education expenses such as tuition, books, and room and board are tax-free. This can lead to incredible tax savings. For instance, if a father contributed $12,000 to his daughters 529 plan the day she was born, assuming a 10 percent interest rate, the account will be valued at $66,719 the day the daughter turns 18. That is $54,719 of tax free growth!

529 plans also offer the donor additional estate planning options. These plans are unique in that the gift removes the assets from the contributor's estate, yet the contributor still controls the funds. The removal of the funds from the donor's estate is an advantage because if the donor dies, funds contributed will not need to go through the probate process, which can be timely, expensive, and confusing. However, the donor still controls the funds and can change the beneficiary of the account or even refund the money to himself or herself at anytime. Of course, if the donor chooses to refund the money, taxes and the 10% penalty will need to be paid.

The last advantage of 529 plans are derived from the plan's contribution limits. In 2008, an individual can contribute up to $12,000 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 $60,000 to a plan in year one, but would then be prevented from contributing to the plan during years two thru five.

However, a drawback of the 529 savings plan is that if the funds are withdrawn for a purpose other than for higher education, all growth will be taxable as ordinary income AND will be hit with an additional 10% penalty. So what happens if the child does not attend college? Of course, the child can withdraw the funds and pay the taxes(kiddie tax laws may apply, causing the child to pay taxes at their parents marginal income tax rate) plus the penalty. A far more attractive option would be for the person who contributed the funds to change the beneficiary on the account. The beneficiary of the funds can be changed at anytime, as long as the new beneficiary is a member of the original beneficiary's family. The new beneficiary can then reap all the tax advantages of the 529 account, as long as the funds go towards qualified higher education expenses.

Contributions to a 529 plan must be completed by the end of the calender year.

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