Section 529 Plans Are Flexible—Truth or Myth?
Section 529 plans offer a certain amount of flexibility and control—or do they? Unlike a number of investment vehicles, such as custodial accounts (such as the Uniform Gifts to Minors Act) and Coverdell accounts (used to pass money to minors, as explained on page 135), you never surrender your control over a Section 529 plan. This remains true even after the potential beneficiary reaches the age of majority (usually eighteen, but twenty-one in some states).
Beneficiaries Can Change
The owner of the account is the person who contributes the money. The designated beneficiary is the student, current or future, who will receive the benefit. The owner of the account can change the beneficiary after participation in the Section 529 plan begins. You should check with your plan provider to find out how often and when you can change beneficiaries. There is no age limit for the beneficiary, so the funds can be used for undergraduate or graduate education.
The account holder retains sole discretion in deciding when account withdrawals are made and for what purpose. For instance, if your student is awarded a full scholarship or (heaven forbid) decides that college life is “just not meant for him” or “not in her destiny,” you can still change the name of your Section 529 beneficiary. Investors are also able to reclaim their funds and return the invested amounts to their private estates. In this case, the withdrawals become subject to federal income taxes as well as a 10-percent tax penalty. What's even better is that you are allowed to start up as many Section 529 accounts as you need and/or want. You would be able to start one account for each child.
In determining federal aid eligibility for a student, the U.S. Department of Education does not currently require financial aid administrators to count as income any distribution from Section 529 plan investments. However, some institutions do count the money as untaxed income of the student when awarding institutional aid, and this may affect the student's institutional grant eligibility.
Plans Vary from State to State
The tax benefits that may be possible if your Section 529 plan is in your state of residence could provide you with an incentive to invest in your home state's plan. Most state plans allow students to attend colleges and universities across the United States, so where you choose to invest should not necessarily restrict your student's choices. When you compare the plans offered by different states, you may find one in another state that is a more attractive investment option (better historic rate of return, lower annual account fees, plan flexibility).
Rollovers from one plan to another are generally allowed. Investors may choose to do a rollover for the same performance reasons you would roll over a retirement plan. If you consider a rollover from one state's plan to another, just be sure to review the originating state's requirements for any restrictions before you make your decision.
Choose Your Own Contributions
There are absolutely no income limits on individual contributors to Section 529 plans, so anyone can contribute, no matter how much money they make. If annual contributions exceed $11,000, gift taxes begin to apply; the maximum amounts allowed for contribution on behalf of each designated beneficiary vary from state to state. The $11,000 annual contribution ceiling (the point at which federal gift tax begins to apply) is also subject to limitation, as it assumes that the contributor has made no other monetary gifts to the beneficiary in that same tax year.
Keep in mind that you are only granted one gift tax exemption for each of your children. If you start Section 529 plans in two different states, both for the benefit of the same child, then your collective contributions to both accounts would count toward your gift tax exclusion.
In certain situations, an investor can make contribution payments up to five years in advance. An individual contributor can make a single contribution of up to $55,000, and married couples can contribute $110,000 in one lump sum. Beneficiaries are subject to a lifetime limit, which is commonly set in excess of $200,000.
Withdrawals for Whatever You Want?
Most withdrawals from Section 529 college savings plans are exempt from federal taxes. Of course, that's only if the money is used as intended, for qualified educational costs. The owner of the fund can withdraw the money for other expenses. However, this incurs a 10-percent penalty, and you also subject those Section 529 funds to federal income taxes. Some plans have a one-year waiting period before any distributions can be made. If the student is close to college age, you may want to check on the distribution requirements of various plans before choosing a particular one.
Some Section 529 plans charge some form of a fee for management or annual account maintenance. The tax advantages that many state plans offer may help to balance the costs for a number of Section 529 plan mandatory fees.
If the Section 529 plan beneficiary receives a scholarship, funds can still be withdrawn without penalty (music to everyone's ears!). However, the withdrawals are only tax exempt up to the total amount of scholarship award. In the event of the beneficiary's death or disability (though hopefully this will not be the case), withdrawals remain tax-exempt. However, your 529 account earnings would be subject to federal income taxes.