Series 26

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Retirement and College Savings Plans - College Savings Plans


Coverdell Education Savings Account (ESA)
The Coverdell ESA, also known as the education IRA, was created in 1998 to give parents a tax-advantaged account in which they could save money for a child's college education. Anyone who has an adjusted gross income that falls within the government limits may contribute a maximum of $2,000 per year into an account that is established for the benefit of ("FBO") the child. The AGI phase-out for single parents is $95,000 to $110,000 and it is $190,000 to $220,000 for married parents.

While contributions are not tax deductible, the money within the Coverdell ESA grows tax-deferred and is tax free if used for qualified educational expenses at an institution of higher education, including tuition, room and board, and other related costs. The money must be used by the beneficiary's thirtieth birthday or it must be distributed and subject to ordinary income tax and a 10% penalty on the earnings. The same restrictions also apply to any non-education related withdrawals made before the beneficiary's thirtieth birthday.

With the increasing costs of education, these instruments have become increasingly popular with parents. Learn more about these accounts within the following Education Savings Account tutorial.

Section 529 Plans
In the last few years, one of the most popular accounts has been the Section 529 plan, known to most investment reps as simply a "529". The federal tax treatment of state-run 529 plans was modified by the Economic Growth and Tax Relief Reconciliation Act of 2001 to allow for federally tax-free treatment of qualified withdrawals. In other words, if contributions to 529 plans were used for qualified educational expenses, such as tuition, room and board, books, lab fees, and other education-related costs, any earnings and gains on the principal amount invested was free of federal income taxes.

Each state determines the specific rules that govern contribution amounts, investment choices and state tax deductibility. In addition, a state may have two or more state-sponsored 529 plans, each administered by a particular investment company. Parents can construct a mutual fund portfolio based on the child's age, an assortment of pre-selected asset allocation models developed by the fund company, or their investment representative's recommended fund choices. Earnings and capital gains are reinvested in the funds and grow tax-deferred as long as they remain inside the account, and they come out free of federal taxes if used for qualified educational expenses. Lifetime contribution amounts per beneficiary can be as high as $255,000 in some states. While contributions are not federal-tax deductible, some states allows state income tax deductions for residents.

Two of the main benefits of the 529 plan involve ownership and beneficiary designations. Unlike custodial accounts, where the child gains custody of the money in the account upon reaching the age of majority, the parent, grandparent, distant relative or family friend can start a 529 as owner, for the benefit of a child. If the child decides not attend college, the person who started the 529 can switch the beneficiary designation to another child or even use the funds for his or her own continuing education. Any withdrawals from the 529 that are not used for qualified educational purposes are taxed as ordinary income and subject to a 10% penalty.

If you would like to have a little more information on 529 plans, consult the 529 Plans tutorial.

Before recommending a particular 529 plan to a client, be sure that you are recommending the right kind. Learn more about the different types within the Choosing the Right Type Of 529 Plan article.

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