Many people have been expressing interest in college savings plans. Even though we discussed these plans in a prior blog, I thought we could revisit the issue, giving more information and highlighting the benefits of these tax advantaged plans.
College savings plans are part of section 529 of the income tax code and are usually operated by the state. The purpose of section 529 is to help folks save and pay for college. Taking advantage of these plans can help your student reduce their need for student loans.
So how does it work?
- The parent (or grandparent) sets up the plan, naming themselves as owner and the student as the beneficiary of the plan. It is advisable to name a successor owner in case something happens to the owner.
- Contributions made to the plan are non-deductible for federal income tax purposes but may be partially deductible for state tax purposes.
In Nebraska (where I live), Nebraska residents making contributions to the Nebraska college savings plan can deduct contributions up to $10,000 for 2014. This is an increase from the 2013 amount of $5,000.
- Annual contributions are generally limited to the amount of the annual federal gift tax exclusion ($14,000 for 2014 and 2015). Larger amounts can be contributed each year but the donor will be required to pay gift tax on any amount greater than the annual gift tax exclusion.
- Earnings in the plan are never taxed as long as the distributions are used to pay the qualified higher education expenses of the beneficiary.
- The student beneficiary can be the beneficiary of more than one college savings plan. For example, the student’s parents could set up a plan with themselves as owner and so could the grandparents.
- The owner of the plan can be owner of multiple plans with different beneficiaries. For example, a grandparent can set up four plans, one for each of his/her four grandchildren.
- For most plans, distributions out of the plan can be made to the educational institution, to the student beneficiary, or to the owner of the plan. If distributions are made to the student or the owner, careful records of expenses should be kept to prove, for income tax purposes, that the expenses equal or exceed the amount of the distribution.
- Any distributions made that are greater than the qualified education expenses will be taxable income.
- If the student beneficiary doesn’t use all the money in the plan or doesn’t need it, the beneficiary can be changed to another family member.
What are “qualified higher education expenses?”
- Costs required for enrollment or attendance at the eligible educational institution
- Tuition.
- Fees.
- Books.
- Supplies.
- Equipment.
- Room and board costs (subject to a limit) for students attending at least half-time.
- Total annual qualified expenses must be reduced by non-taxable scholarships or educational assistance received by the student.
What are the benefits?
- College savings plan funds reduce or eliminate the need for student loans.
- Students can be the beneficiary of more than one plan.
- Earnings are never taxed as long as they are used for “qualified higher education expenses”.
- Some states allow a tax deduction for contributions.
- Student beneficiary can be changed.
- Distributions can be made directly to the college
Have questions? Contact us or go to www.irs.gov.
Judith Ackland has more than 26 years of experience in accountancy and financial planning, including seventeen years as a CFO of a diverse business. She started Crystal Financial in 2010 to help a wide array of individuals, families, and business owners better understand their finances and how good financial management could help them achieve their goals. Judith has an MA in Professional Accountancy from the University of Nebraska at Lincoln as well as a Certified Public Accountant Certificate and a Certified Financial Planner designation.
