Qualified Tuition Program - 529 plans

If you have a child (or a grandchild) who's going to attend college in the future, you've probably heard about qualified tuition programs, also known as 529 plans (for the Internal Revenue Code section that provides for them), which allow prepayment of higher education costs on a tax-favored basis.

There are two types of programs: prepaid plans, which allow you to buy tuition credits or certificates at present tuition rates, even though the beneficiary (child) won't be starting college for some time; and savings plans, which depend on the investment performance of the fund(s) you place your contributions in.

You won't get a federal income tax deduction for the contribution, but the earnings on the account aren't taxed while the funds are in the program. You can change the beneficiary or roll over the funds in the program to another plan for the same or a different beneficiary without income tax consequences.

Distributions from the program are tax-free up to the amount of the student's "qualified higher education expenses." These include tuition (including up to $10,000 in tuition for an elementary or secondary public, private, or religious school), fees, books, supplies, and required equipment. Reasonable room and board is also a qualified expense if the student is enrolled at least half-time.

Distributions from a 529 plan can also be used to make tax-free payments of principal or interest on a loan to pay qualified higher education expenses of the beneficiary or a sibling of the beneficiary.

Distributions in excess of qualified expenses are taxed to the beneficiary to the extent that they represent earnings on the account. A 10% penalty tax is also imposed.

Eligible schools include colleges, universities, vocational schools, or other postsecondary schools eligible to participate in a student aid program of the Department of Education. This includes nearly all accredited public, nonprofit, and proprietary (for-profit) postsecondary institutions.

However, "qualified higher education expenses" also include expenses for tuition in connection with enrollment or attendance at an elementary or secondary public, private, or religious school.

A school should be able to tell you whether it qualifies.

The contributions you make to the qualified tuition program are treated as gifts to the student, but the contributions qualify for the gift tax exclusion amount ($15,000 for 2020, adjusted annually for inflation). If your contributions in a year exceed the exclusion amount, you can elect to take the contributions into account ratably over a five-year period starting with the year of the contributions. Thus, assuming you make no other gifts to that beneficiary, you could contribute up to $75,000 per beneficiary in 2020 without gift tax. (In that case, any additional contributions during the next four years would be subject to gift tax, except to the extent that the exclusion amount increases.) You and your spouse together could contribute $150,000 for 2020 per beneficiary, subject to any contribution limits imposed by the plan.

A distribution from a qualified tuition program isn't subject to gift tax, but a change in beneficiary or rollover to the account of a new beneficiary may be.

If you'd like to further discuss how the qualified tuition program might help to meet your child's future college costs, please contact us.