How
Are You Going To Pay for College?
An
ever important question from parents is how to save for
their child’s college tuition. Section 529 College Savings
Plans, covered under Section 529 of the Internal Revenue
Code are one of the best options a parent could choose.
Qualified withdrawals from Section 529 plans are now completely
tax-free as a result of the Tax Act of 2001.
There
are choices and limitations to Section 529 plans. National,
state, and specific colleges offer plans to help parents
save money for their child’s continuing education in a way
that provides some strong tax benefits and wonderful savings.
SPECIFIC
TO VIRGINIA COLLEGES AND UNIVERSITIES
Smart
Money Magazine rates Virginia among the nation’s top
four states in terms of its college savings plans. These
plans offer Virginians many different opportunities to save
for a child’s college education.
One
option is VPEP (Virginia Prepaid Education Plan) which locks in tuition at today’s prices to cover future
tuition and mandatory fees at state colleges and universities.
The investment can also be used for private and out-of-state
schools, but the program does not guarantee full coverage.
VPEP was created as an independent state agency by the Virginia
General Assembly in the mid-1990s. The plans are in conformance
with Section 529 of the Internal Revenue Code, the set of
rules for which the 529-qualified state tuition programs
are named. VPEP plans allow for monthly payments and have
some great tax benefits.
More
growth potential may be found in VEST (Virginia Education
Savings Trust) which uses a mix of stocks and bonds
to invest for education. VEST portfolios can either be age-based
or "non-evolving", ranging from conservative to
aggressive. These mutual funds contain a constant mix of
stocks and bonds and can be changed once a year. Aggressive
funds are 80% stocks, 20% bonds; moderate funds are 60%
stocks, 40% bonds; and conservative funds are 20% stocks,
80% bonds. A money market fund also is available which is
100% cash. A VEST account is not limited to anyone by age,
residence, or income. VEST programs do not involve a financial
advisor and do not offer financial advice, but are designed
to fit with the child’s age.
Section
529 plans allow contributions to grow tax-free. If used
for a qualified education expense, there is no tax imposed
on the income that is earned and used to pay those expenses.
There are two types of Section 529 plans. A prepaid tuition
plan allows parents to lock in current tuition prices
at state colleges and universities for their child by paying
a lump sum or agreeing to monthly payments, saving them
thousands as college tuition go up each year.
College
savings plans allow you to make contributions to a state-sponsored
savings account and take advantage of many benefits. Any
parent or other qualified family member can invest in a
Section 529 plan, regardless of income. Depending on the
plan you select, contributions can be up to $55,000 in one
year or have the gift count as $11,000 contributions for
each of 5 years. Your spouse can make a one-time gift of
$110,000. Assets in a Section 529 plan can easily be transferred
among relatives including a sibling, grandchild, niece,
nephew, or cousin if the intended beneficiary chooses not
to go to college or the child receives a scholarship. The
money invested in a state-sponsored plan can be used at
any accredited college or university in the nation. If you
do not like the plans that Virginia has, you are able to
invest in plans from other states. There is no time limit
attached to the plan, so it is fine if the beneficiary takes
a few years off after high school.
Each
state selects an asset management company that oversees
the plan. Some plans have a guaranteed floor and moves your
investment through age-appropriate securities. For example,
investments for younger children begin in equity-heavy securities,
but they move into money market funds or bonds as the child
gets closer to entering college. The funds you choose can
be changed every 12 months.
There
is no up-front deduction for Section 529 contributions but
investments do grow tax-free. Qualified withdrawals are
exempt from federal taxes. However, if a withdrawal is not
qualified the income is taxed. A penalty is not imposed
if a beneficiary receives a scholarship or passes away before
the money is used, but the income received is taxed. In-state
residents get additional benefits by receiving a state tax
deduction for contributions up to a certain amount.
Section
529 plans offer advantages over distributions made under
the Uniform Gifts to Minors Act (UGMA). Under Section 529
Plans, the parents retain control until the funds are dispersed
to the college or university. The funds do not automatically
go the child when he or she reaches 18. However, once the
child receives their gift, the income level of the child
is increased. On the FAFSA form, the government allows for
35% of a student’s income to be allocated for college tuition.
Only 5.6% of the parents’ income is allocated to pay for
a child’s education. A sizable UGMA donation could hurt
a child’s opportunity to get federal grants and loans as
the income of the child is increased. Financial aid eligibility
is not impacted as greatly under a Section 529 plan because
contributions are treated as an asset of the parent, not
the child.
Parents
should not seriously consider investing in a college savings
plan unless they are secure for their retirement. There
are always loans, tuition credits, scholarships, and grants
to help someone finance college. There are none of these
things to help a person once he or she retires and is unemployed
for 30 or so years. Parents might want to maximize his Roth
IRA contributions if they meet the income limits. These
contributions could be pulled out to pay for college expenses
without a tax impact or the imposition of a penalty.
There
are many advantages to investing in a Section 529 plan,
but there are disadvantages. If you make an unqualified
withdrawal from a Section 529 Plan, you will owe a 10% penalty
in addition to having to pay both federal and state taxes
on the earnings. Know what you are getting into before you
make any investment decision.
What
Should You Consider When Evaluating a 529 Plan?
WHO
IS ELIGIBLE?
-
Who
can open an account?
-
Who
is treated as the account owner?
-
Does
the owner or student have to be a state resident?
-
Are
there any age restrictions on who can open an account?
WHAT
DOES THE PLAN COVER?
IN
REGARDS TO THE BENEFICIARY...
-
What
happens if the beneficiary does not attend college?
-
What
is the procedure for changing a beneficiary? Who is
eligible?
-
What
happens if the beneficiary dies or becomes disabled?
-
What
happens if the child receives a scholarship?
WHAT
ARE THE RULES...
-
How
long the funds can remain invested in the plan?
-
What
are the minimum and maximum contributions allowed (annual
and cumulative)?
-
What
is the penalty on nonqualified distributions?
-
Are
rollovers allowed to/from other state 529 programs?
What are the terms?
-
What
happens to account ownership in the event of death or
divorce of the owner?
-
Can
the owner get a refund of the account? If so, what are
the terms?
-
Is
there a limit on the number of credit hours a student
can take when he or she enters college?
SAVING
YOURSELF FROM ADDITIONAL FEES...
HOW
DOES THE PLAN WORK?
-
What
are the investment options? Are these compatible with
the client’s risk tolerance?
-
Who
is the investment manager?
-
What
are the fees associated with the manager?
-
How
are distributions made?
SAVING
MONEY ON STATE TAXES...
-
Are
contributions deductible for state tax purposes?
-
Are
account earnings subject to state income tax and if
so, when?
OTHER
CONSIDERATIONS...
FOR
ADDITIONAL INFORMATION:
www.collegesavings.org
www.savingforcollege.com
www.virginia529.com
www.cfionline.com
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