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529 E-ditorials

01-5: All I can say is WOW!
Joe Hurley
Tuesday, May 29th 2001

An extraordinary thing happened this past weekend. Congress passed full federal income tax exemption for 529 plans. This means that, beginning in 2002, your beneficiary will no longer have to report income when withdrawals are used for qualifying college costs. President Bush is expected to sign the bill into law this week or next.

Should this affect your college investment decisions? You bet. You can now resist the lure of low capital gains rates on UTMA accounts. And banish the idea of using your Roth IRA for college expenses. U.S. savings bonds? Just not as good. Even the Education IRA, with its annual contribution cap raised from $500 to $2,000 and improved in other ways under the same tax bill, pales in comparison to the power of the 529 plan.

Think about it. You are able to contribute $50, $5,000, $50,000, or even $250,000 to a 529 plan for each of your kids or grandkids, no matter where you live and without regard to your income level. The account might triple in value (we should all be so lucky), and you will still be able to take withdrawals free of income tax as long as those withdrawals are used for your beneficiary's college and graduate school expenses.

Even the gift tax consequences of large contributions to a 529 plan will become less of an issue. The tax bill boosts the lifetime exemption amount from $675,000 currently to $1 million in 2002. (This is above and beyond the $10,000 annual gift exclusion.)

And I shouldn't neglect to mention another significant change to 529 plans made by the new bill. You will be allowed to roll over your account tax-free and penalty-free to a different state 529 plan as often as once every 12 months. You will not be required to change the beneficiary on the account, as current law demands. The reason this is important is because it gives you the opportunity to change your investment if you like, despite the continuing rule under section 529 prohibiting investment direction. I never liked the investment direction prohibition, and now Congress gives us an easy way around it.

What better incentives could there be to save for college? Why would anyone with the financial resources not want to start using college savings plans and prepaid tuition plans instead of pinning their hopes on a federal financial aid system that is bound to disappoint. (Financial aid should continue to assist those who really need the help.)

If I sound like I am unabashedly selling 529 plans, please forgive me. I will be the first to point out that there are still many considerations in planning for future college expenses, and everyone's situation is unique. Other types of investments - mutual funds, Education IRA, savings bonds, variable universal life - can still be a good way to go for at least part of your college savings fund. And certainly you should continue to pay attention to your retirement needs with the 401(k), Roth IRA and other appropriate vehicles.

But at least now we have less reason to worry that income taxes will reduce the amount we have available in the future to pay for ever-increasing college costs. We will better afford the higher education that is so vital for our children, our grandchildren, or even ourselves.

Is the new law all good news? Not quite. To comply with certain budgetary laws, the changes made will "sunset" in 2010 unless Congress later decides to extend them. That makes us a little nervous. Also, the new rules will serve to make your planning more complex and your tax returns more complicated. In fact, some of this will really make your head spin. will continue to try to help you make sense of it all.

» 05-4: The 529 marshals have arrived - 08/30/05
» Our 5.29th-year anniversary - 06/29/05
» 05-2: 529s and the new Bankruptcy Act - 04/28/05
» 05-1: Reform or Deform? - 02/27/05
» 04-6: Perspectives on the 529 debate - 12/28/04
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