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COLLEGE SAVINGS 101

529 plan for older, 'iffy' students

07/31/2006

QUESTION:
Dear Joe,

I have something of an unusual question regarding 529 plans, designed for funding college educational expenses.

I'm considering opening a 529 plan for myself (a 35-year-old single female) as a means of putting away some additional money. I may, at some point, decide to go back to school (I have no children and do not plan to have any, so my question is only in reference to myself). In fact, while I have no plans for a master's degree, I could see myself being quite happy spending a significant amount of time on educational pursuits in my retirement. I've read the overviews on 529 plans and understand that I would, eventually, have to pay a 10 percent penalty (plus the regular taxes) on the earnings when distributed if I didn't use it to pay for educational expenses. Still, I'm currently maxing out my 401(k) contributions and I think this may be a viable option to further my retirement fund, even if I never decide to go back to school.

What are you thoughts on this? Is there any more serious tax complication than what I'm reading in the FAQs regarding 529 plans? Can I even open a 529 plan for myself? And over the long haul, would I be better off to invest in an IRA or some other vehicle, even if I decided to use the money for education at some point down the road?

Thanks in advance for your advice!
-- D.B.

ANSWER:
Dear D.B.,
I heartily endorse your plan. 529s are flexible enough to accommodate the educational aspirations of adult Americans, even if you cannot be certain you will ever return to school. In fact, having the money set aside in a 529 plan may ultimately spur you to enroll in a college course, whether it's to pursue a degree or not.

I can point to my own family's experience as proof. When our kids became teenagers, my wife decided to return to school for a master's degree, which has helped her to advance her career in nursing. She occasionally talks about going back for even more schooling. And, yes, my wife does have a 529 account that names her as beneficiary. Even if she never returns to the ivory halls, she can keep the account intact for the educational needs of our children, future grandchildren or even great-grandchildren.

You mention you don't expect to have children or grandchildren of your own. But you may have nieces, nephews or other family members with educational aspirations. If you at any time decide to redirect your 529 funds to another family member, it will be an easy matter to change the beneficiary on your account or make a partial rollover to an account with another family member named as beneficiary.

In the "worst case," you will scrap your idea to return to school and instead use your 529 account for noneducational purposes. The account growth will be subject to ordinary income tax and an additional 10 percent tax if you withdraw it on a nonqualified basis.

Because of the tax and penalty, you may end up with less money than if you had decided to put your savings into mutual funds or other taxable investments from the outset. The outcome depends on several factors, including tax rates in the future, your tolerance for risk and your desired mix of stocks and bonds. Fixed-income investors will benefit more from the 529 tax break than those looking to invest in growth stocks. But the analysis must also consider the extra fees charged by most 529 plans.

Even if you currently prefer equities over fixed income, you may want to adjust your asset allocation later on. A 529 plan gives you the ability to change your asset mix at least once per year without taxes by switching investments or rolling over to another 529 plan. With mutual funds, an exchange constitutes a taxable sale.

The U.S. Treasury Department has expressed concerns about individuals using 529 plans as retirement accounts and has proposed increasing the penalty from 10 percent to 20 percent on nonqualified distributions taken more than 20 years after establishing the 529 account. If this proposal ever makes it into law, it will likely apply only to accounts funded after the enactment date.

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