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The 529 Plan

These plans have become more popular over the past few years. Let’s look at a few pros and cons of 529 plans;

You may deposit up to 5X the annual gift limit (in 2010, the limit is $13,000, so you can give $65,000 per recipient and treat it as 5 years’ of annual gifts. No gift tax is due, but you must file form 709 to declare the amount over $13,000)
Money can grow and be withdrawn tax-free (current tax law).
Funds can be designated for a different relative should the intended child not go to college.
The ‘approved relative’ list follows;

1.Child or descendant of a child.
2.Brother, sister, stepbrother, or stepsister.
3.Father or mother or ancestor of either.
4.Stepfather or stepmother.
5.Son or daughter of a brother or sister.
6.Brother or sister of father or mother.
7.Son-in-law, daughter-in-law, father-in-law, mother-in-law, brother-in-law, or sister-in-law.
8.The spouse of any individual listed above.
9.First cousin.

There is no required distribution, thus you can save early for a yet unborn grandchild if you wish (by designating a child and then changing the beneficiary once the grandchild is born.)

Should you need to withdraw the funds and not use for school, regular income tax rates (not cap gain) apply as well as a 10% penalty.

Fund choices are typically very limited, and you may only change funds once per year.

Tip – MBNA offers a credit card linked to a Fidelity 529 account. You get 2% cash back on all purchases with no cap. There is no annual fee on the card and no annual fee on the 529 account. This is a painless way to save and a far better return than ‘miles’ cards.

  • Ken @Spruce Up Your Finances September 8, 2010, 12:53 am

    Good points. 529 plan is one of the options out there for a lot of parents to fund their kids education but just like any other tax-deferred plans (Traditional IRA, 401k, etc), it does come with the early withdrawal penalty. And you’re right about the limited options for parking the funds.

  • Roshawn @ Watson Inc September 8, 2010, 11:22 am

    Are there income restrictions on the 529 plans?

  • Evan September 8, 2010, 1:41 pm

    Pro – Depending on State contributions may be tax deductible (NY State allows up to 10K per couple)

  • JOE September 8, 2010, 3:45 pm

    No. The Coverdale (known as the Education IRA) has an income limit as well as much lower ($2000) deposit limit. No such restriction on the 529.

  • JOE September 8, 2010, 3:45 pm

    Great point, thanks!

  • B Simple September 8, 2010, 9:32 pm

    Nice summary of the pros and cons of 529s.

  • Car Negotiation Coach September 8, 2010, 9:51 pm

    Joe, If your kid decides college isn’t for them, just how broadly can you use the funds? i.e. Trade school, living expenses during paid schooling (police academy or such), beauty school, peace corps, clown college, etc?

  • JOE September 8, 2010, 10:59 pm

    Good question, Qualified Higher Education Expenses is defined as “Tuition and related expenses that one pays to a university, college, technical school, or other post-secondary institution.” So, Trade school should be okay, along with room, board, and books required. Can’t say about clown school.

  • Wojo September 9, 2010, 3:37 pm

    Seems like a good (and one of the few) vehicles for college savings. We just had our first in January and opened one of these plans right away to start putting away some savings. It is a bit of a risk is none of our kids go to college (who can say whether college will even be a good choice in 20 years?) but I suppose it’s a risk worth taking.

  • Leigh September 9, 2010, 5:32 pm

    Joe – Leigh Mutert from H&R Block here.

    I enjoyed your article. One of the things that makes 529’s so appealing is the opportunity that you mentioned above about rolling it over if the original beneficiary doesn’t need the funds (or only needs part of them). The person who funded the account may end up with surplus and decide that they should be the next beneficiary. Some Seniors are now funding their own post-sec work with 529’s that they originally set up for grandkids. As long as they are enrolled at least half-time and the school is eligible to participate in a student aid program administered by the U.S. Department of Education, it’s a great way to enhance life skills.

  • JOE September 9, 2010, 5:35 pm

    Leigh – thank you for the visit and comment, honored to have you stop by. Excellent additional details for my readers.

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