Tax Information: What Is IRS Section 529?

With tuition costs skyrocketing, it is important that parents start saving early for their children's educations. Section 529 plans may be the answer.

Title 26 of the United States Code is one of the scariest sections for many people. It is commonly known as the Internal Revenue Code, or IRC. While it is relatively easy to find the IRC -- there are many web sites with copies of it available on the Internet -- it isn't quite as easy to read it, especially the interesting parts about how to save money on your taxes.

(For specific matters pertaining to your income tax return, please speak to a financial advisor or an accountant. This article is for general information purposes only.)

Title 26, Subtitle A, Chapter 1, Subchapter F, Part VIII, Section 529 is the proper way to refer to the laws governing Qualified Tuition Programs (QTP's), but most people just call them Section 529 plans. Every state has at least one, and you aren't limited to using the plan in your own state. These are savings plans for college tuition to which many people may contribute for the benefit of a single person. Parents, grandparents, aunts and uncles, even brothers and sisters can all pitch in to help pay for college some day in the future. There are several rules for what qualifies as a Section 529 plan, of course.

1. A qualified tuition program must be run by a state government, or one of its agencies, or by one or more eligible schools. In the state run programs, people can make contributions to a special account that is designed specifically to be used to pay for tuition and other education related expenses. The contributions can be used at virtually all colleges, universities, and vocational schools. Programs run by the schools allow people to buy tuition credits for future use at that particular school.

2. QTP's must only allow cash contributions. All contributions must be on the spot, no stocks or bonds, although you may be able to roll U.S. savings bonds into a 529 plan.

3. Contributors to these programs can not direct the investment of the funds, and neither can beneficiaries.

4. Interest earned on qualified tuition plans may not be used to secure a loan.

5. 529 plans must have measures in place to ensure that excess contributions are not made. Excess contributions are those that are greater than the beneficiary would need for standard education expenses.

6. The plans must have separate accounting for each beneficiary.

There are many benefits to 529 plans. Money contributed to a QTP is tax-deductible, and distributions made to the beneficiaries are not considered income. This is a nice tax break at both ends. Many people can make contributions to the same plan, so the money for college is all in one place. The contributors have control of the funds, not the beneficiaries. They can switch beneficiaries within the same family at any time, and some states may even allow the funds to be revoked from the plan (generally with penalties). Plan funds can be rolled over into a new QTP for the same beneficiary or for any member of their family without being subject to taxes. It can be very easy to contribute, too. You may be able to contribute through payroll deductions. There's even at least one credit card that will deposit rebates on purchases into a 529 plan for you.

Some of the drawbacks to 529 plans include the lack of choices for where the money is invested, the inability of the contributors to withdraw the funds without penalty, the high fees (plan enrollment, management, and maintenance fees, for example), and the poor disclosure requirements which make it difficult for contributors to see where their money is really going.

On September 30, 2004, the Senate Committee on Governmental Affairs held an oversight hearing on Section 529 plans. Senators Peter Fitzgerald (R-IL) and Daniel K. Akaka (D-HI) addressed the Committee, suggesting possible changes in the structure of 529 plans. QTP's often invest the plan assets in mutual funds, and the Senators are asking if 529 plans should be subject to the same Security Exchange Commission regulations that the mutual funds are. As of this writing, nothing has been decided on the matter.

With tuition costs skyrocketing to the point where the College Board estimates the cost of a college education at $112,000 for public university in 2020, it is vitally important that parents start saving early for their children's educations. As with any investment strategy, however, Section 529 plans are not the right answer for everyone. To be certain that your money will be put to the best use, talk to a financial advisor or accountant. They should be able to help you come up with the best plan for your future.

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