Summer, 2009

You can now put away thousands of dollars each year for your child's education and not pay income taxes if the money is used for higher education. Internal Revenue Code Section 529 allows states to set up qualified tuition programs which defers income tax and in some cases allows tax deductions at the state level.

States differ in the annual contributions, the total contributions allowed and the professional investment manager used. Some states allow non-residents to participate in their plan but in order to get the state tax deduction you have to file a return in that state. However, a non-resident still can defer the federal and state income taxes on the plan's earnings.

If the money is used for the child's qualified higher education expenses, (tuition, fees, books, supplies) the child will not pay income tax on the earnings as the funds are withdrawn. If the child does not go to college, the funds can be transferred to another child or other family member to be used for the same purpose. If the funds are used for something other than education expenses, the donor will pay the tax plus a penalty of at least 10%.  Penalties vary by state plans.

These plans tend to be very conservative and as the child gets closer to college age, the more conservative they become. As an example, newborn babies investments may be 90% equities and 10% bonds but as the child gets older this allocation shifts by reducing the equity investments and increasing the bond investments. Let's say by age thirteen the investments are 50% equities and 50% bonds but by college age, the investments would have shifted to 20% equity, 40% bond and 40% cash. To recap, the younger the child the greater the risk and return and as the child gets older the risk and return reduces. However, you can choose a single investment or build your own portfolio.

There is also an issue of gift tax. If the annual contribution exceeds $13,000 per child, there could be gift tax implications. Proper planning must be considered to avoid these issues.

Kansas established a 529 Savings Plan that started July 1, 2000. It no longer requires the owner or the beneficiary to be a resident of Kansas.  A deduction of contributions up to $3,000 per year per child per taxpayer will be allowed on Kansas tax returns.  American Century has been hired to manage the plan and investments and the plan is known as LearningQuest. However, you can use any state plan and get the deduction.

Missouri adopted a 529 Savings Plan that started accepting contributions in August, 1999. There is no state residency requirement. Missouri taxpayers can deduct contributions up to $8,000 per year from their state tax return. If the funds are used for higher education expenses there is no state income tax on the earnings. If a donor contributes more than $13,000 in one year, the gift can be spread over five years to avoid gift tax. This plan is managed by TIAA-CREF and is known as MO$T.

Remember, you do not have to participate in your resident state plan nor do you have to attend college in the state you have invested in a college savings plan. Since each state has their own set of rules which regulate their plan shopping around might be useful before choosing your 529 plan. Notice the difference between Kansas and Missouri.

Because of the restricted investments and limited plan managers, these plans may not be the best vehicle to use for college planning. If you would like assistance in developing a college plan or if you have questions about the 529 Savings Plans, please give us a call.