Personal Finance

Money Matters: What you need to know about 529 college savings plans

Q. We recently had a baby and my husband’s parents want to start a college savings plan for her. While this is a very nice gesture we have some concerns because they want to use the NC 529 plan and we’ve heard from friends that some of the tax benefits have changed recently and one couple has lost a lot of money in the plan. Is there a way to ask them to save in a different manner for our daughter’s college or would making another suggestion be considered “looking a gift horse in the mouth?”

A. I think once you have a better understanding of 529 college savings plans you will be fine with your in-laws using this as a way to help save for your daughter’s college.

These plans are named after the section of the tax code that governs the plan (Section 529 of the Internal Revenue Code). A majority of states offer these plans and only a few states restrict their plans to residents, the rest allow anyone in the country to participate. Plans in each state differ in the type of investments offered, fees, freedom to change investments, definitions of higher education, contribution amounts and other important features. If you don’t like the type of investments or any other characteristics of the plan offered in your state you could investigate plans offered by those states allowing non-resident participation. You can even set up plans for the same child in more than one state. With that said, the North Carolina plan has improved over the years, the fees have been reduced and the investment selections have improved. The only negative change has been the elimination of the state tax deduction for contributions made in years 2014 and after.

I’ll touch on a few of the most appealing features of a 529 plan but you will want to read the program description of the NC plan at www.cfnc.org for more detailed information. For information and ratings on all 529 plans you can go to www.savingforcollege.com, a web site maintained by Joseph Hurley, CPA. He rates plans based on factors such as fees, expenses, tax incentives and gives them a “cap” rating (graduation caps) with 5 caps being the highest and 0 being the lowest. The NC plan has 4 caps.

Some of the major advantages of this plan as a college savings tool follow:

▪ Investment gains within these savings plans enjoy the benefit of tax deferred growth and may be tax free if used for qualifying higher education expenses. Any dividends, interest or capital gains aren’t taxed if used to pay for higher education tuition, fees, books, room, board, supplies and equipment.

▪ Unlike custodial accounts, the money in the plan doesn’t become the child’s property at legal age (usually 18 or 21). You don’t run into the problem of wondering what your son or daughter may do with the funds once they reach 18 or 21. This problem is eliminated because the account remains in control of the person that established the account. A child is the named beneficiary but he or she has no right to the funds in the account. The account owner decides what to withdraw when and for what purpose.

▪ If the beneficiary of the account doesn’t go to college or if there is more money in the account than needed for college, several options are still available. The beneficiary can be changed to a new related beneficiary. The account owner is also allowed to withdraw the money from the account for their own use. This would be a non-qualified withdrawal and subject to a 10 percent penalty and any earnings would be taxed at the owner’s income tax rate.

▪ The maximum contribution to a 529 college savings plan varies by state. All contributions qualify for the $14,000 annual gift tax exclusion. If anyone wants to contribute more than $14,000 in a year there’s good news. The plans allow a gift of up to $70,000 in a one-year period to be treated as if it were made over a 5-year period. This allows a large contribution to be made without triggering the gift tax. A married couple may use the gift splitting election and contribute $140,000 in one year for a beneficiary. No more contributions may be made for 5 years without triggering the gift tax.

The NC 529 Plan will sponsor 5/29 Savings Play Day at Marbles in downtown Raleigh on May 29. Families will have the opportunity to get hands-on with financial literacy and learn about NC’s college savings program and the importance of planning ahead. NC 529 Plan will also be the presenting sponsor of the annual Kick-Off to Kindergarten school readiness events at Marbles.

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