April
29, 2002
Peter
Kolar
Brandon
Ebert
John
Reuter
Executive
Summary 2
Introduction 3
What is a 529? 3
Tax Implications 3
When do I start
investing and for what can the money be used?
4
Transferability 5
Savings and
Financial Aid 6
Estate
Implications 6
Plans for
Personal Education 7
What Parents
Should Know 7
Advantages and
Disadvantages 9
Where is the 529
Plan Going? 10
State-by-State
Differences 11
State of
Nebraska 11
Coverdell
Education Savings Accounts 11
Coverdell
Education Savings Account Guidelines 12
How to Establish
a Coverdell Education Savings Account 12
The Coverdell
Education Savings Account and Tax Implications 13
Conclusion 14
Glossary 15
Bibliography 16
Appendix 1 18
Appendix 2 19
In the past,
people all over the country have consistently been concerned with their
retirement and have, as a result, become avid investors. It has become crucial for people to begin
thinking about their retirement at a young age. Millions of young people have begun investing in mutual funds,
stocks, bonds and CD’s. Recently,
though, it has become equally important to think about your children’s education
as well as the costs involved. Over the
years, college tuition has climbed dramatically and, therefore, many people
have been left scrambling to pay the bills.
In fact, according to statistics, the inflation of college tuition over
the last 30 years has consistently averaged two to three percent higher than
the inflation of general prices, with the cost of private school tuition
soaring on average five and a half percent from the year before.[1] This year alone, the tuition of our own
Creighton University will leap by a spectacular 10.3%.[2] Consequently, millions of Americans have
been left looking for ways to afford to send their children to college. Fortunately, Education IRA’s, also called Coverdell Accounts,
and 529 Education Savings Plans
have arrived to help the parents and the students of America.
529 Education
Savings Plans allow parents to save for their children’s education on a
long-term basis. The plan, which
received its name from the section in the Internal Revenue Code in which it is
discussed, Section 529[3],
lets parents gather funds in tax-free accounts. The actual name of the plan is the Qualified Tuition Program[4],
although most refer to it as the 529 Plan.
The funds in these accounts can then be used to pay tuition of colleges
and universities. In addition, if
parents so choose, they can prepay huge amounts of college tuition, up to
$200,000[5]
in some instances. Many people have
taken a sudden liking to the 529 plans due to their preferable tax benefits,
which will be discussed later. Also,
the rules regarding for whom the accounts may be set up are very
favorable. Additionally, since 529
plans have no income limits, wealthier people who pay more income taxes are
also allowed to invest in these accounts.
This is often not the case with many other educational investing tools.[6] 529 Plans have some similarities with other
accounts, such as Education IRA’s, but the attractiveness and the overall
benefits of 529’s show through quite vividly.
Since the savings plan is usually preferred to the prepaid tuition
program, the majority of this paper will be relating mostly to the savings plan
portion of the 529.
As previously
mentioned, 529’s have become incredibly eye-catching due to their very
preferred tax benefits. Investors are
always looking for ways to lower the amount of taxes they have to pay. Luckily, there are many tax benefits that
are involved with college savings accounts. For instance, the money that is
invested in the account grows tax-deferred until the time the money is taken out
tax-free. Additionally, when the
money is taken out of the account, it can be taken out tax-free. Essentially, this means that, when and if
you take out money from the account for any educational purpose, you will not
be obligated to pay any federal income taxes whatsoever. This benefit came into effect on January 1,
2002, so it is a very recent occurrence.
The rules of 529 Plans require that the money that is being invested in
the accounts consist of after-tax money, after tax cash to be exact. Obviously, the money has to be taxed at some
point and, since it is not taxed when it is withdrawn for qualified educational
purposes, it has to be taxed before.
This is why the investment must consist of after tax money. The great benefit comes from the fact that
the money earned is not affected by taxes.
When you are not required to pay federal income taxes on capital gains,
such as the gains made from the money invested in a 529 Plan, then the money is
allowed to compound much more quickly then it would if investors had to pay
taxes on the money every year.[7] These great tax benefits are not the only
ones, though. Additionally, in some
states, the money that is used to make a contribution to the account can be
deducted from income when calculating state income tax due. Many people, depending on the state in which
they live, can receive tax deductions on the money that they invest for
education. Also, as mentioned earlier,
since there is not an income limit on who may invest in these plans, wealthier
people who traditionally have not had access to these plans may invest as
well. While many parents look intensively
for plans that have the greatest tax benefits, they need look no further than
529’s.[8]
Obviously, the
sooner parents begin investing for their children’s education, the better. Regardless of whether you have children yet
or not,[10]
you can begin investing for their future, much like investing for
retirement. The longer that the funds
in the account have to grow tax-free, the more money you will be able to take
out tax-free when it is time for your children to attend college.
Much like the
Education IRA, the tuition money that you have prepaid or the funds that you
have put in an account to grow can be used for nearly all of the expenses
traditionally involved in attending a university or a college. These traditional expenses include tuition,
extra fees, books supplies, room and board, and any equipment that the student
may need.[11] This is very beneficial, because many other
current College Savings Plans, such as the Series-I Savings Bond, can only be used
for tuition and extra fees. It is
important to many people that such things as books and room and board are
included in the availability of funds due to the fact that room and board and
books make up a significant amount of the college or university cost.
In many cases,
parents worry about the possibility that their children will not want to attend
college or will drop out. They wonder
what will happen with the lifetime of prepaid tuition they have invested in or
the funds that they have put in accounts to grow. Luckily, this concern has been addressed. The money that has been invested in the 529
Savings Plan can be used for any child that happens to cross through your
life. If not used for your own
children, it may be used for your nieces or nephews, grandchildren, cousins,
friends or even your paperboy.
Basically, the beneficiary of the plan need not
be a blood relative of the person who has funded the account.[12] Unfortunately, if your child does decide to
not attend college or to drop out, the funds do still have to be used on
educational purposes. Since the funds
have to be used for tuition, equipment, roam and board, fees or books, the
parents cannot simply take out the funds after discovering that their children
are not planning on attending college.
So, this investment can be a problem if you do not wish to transfer the
account to another child. As you will
later see, though, funds may be taken out, but with a large fine involved.
Additionally,
many people adore the 529 Plan for the transferability that it offers. With many investments, investors are forced
to keep their investment within the state in which they initially invested. With the 529 Plans, however, parents are
allowed to transfer from state to state, even after the Plan has been
started. Furthermore, since there is
great competition between states to attract new investors, there are constantly
new offers from various states.[13] Because many states are now yearning to
attract more of their own residents, they are beginning to offer incredible
deals, such as tax deductions and financial aid benefits[14]
to in-state investors. There are some
limitations, though. For example,
investors can only switch from state to state once per year. As of September 1, 2001, though, the
government allows you to switch the investments categories in which you invest
in once per year.[15] This is an improvement from the previous
rules in which investors were not allowed to switch their investment categories
for any reason.
Beyond the
transferability issue, it is important to note that parents can keep the funds
in the account for as long as they like.
They have to remember, though, that the funds must be used for
educational purposes. However, if these
funds are used for non-educational purposes, they will be subject to state and
federal income taxes as well as a withdrawal fine of up to 10%.[16] This is a severe penalty for not using the
funds for educational purposes. As
mentioned before, there is a minimum time limit that the money must remain in
any one plan before it can be transferred, although not before it can be taken
out. Parents who wish to transfer the
funds from one account to another or remove the funds altogether must, according
to the government, wait at least one year before doing so. The problem with this, though, is that the
funds in the account will not have sufficient enough time to grow, thereby not
helping the investor at all and eradicating the entire purpose of the initial
investment.
Many financial
planners have tried their best to steer potential educational investors away
from investing in 529 College Savings Plans due to the pitfalls that arise in
regards to financial aid. They warn that
investing in 529 Plans will have a negative result because the withdrawals are
recognized as income. Luckily for
investors, though, this is not the case.
As will be discussed later, the assets (cash) in the 529 accounts are
actually in the name of the parents of the student for which the funds were
invested. Most likely, according to
most financial advisors, 529 Plans will be regarded simply like all other
parental assets are regarded when determining the possibility of financial
aid. Moreover, many other financial
advisors believe that it will be nearly impossible for anyone to track the
withdrawals of 529 accounts since the new tax-free tax laws have taken effect
and, therefore, they will not have a great impact on the determination of
financial aid. According to Jack Joyce,
the Director of Guidance Services for the College Board, “Families that can
save for college are so much better positioned than those who choose not to
save for the sake of financial aid.[17]” He also states that when all else fails, in
a last ditch effort to still receive financial aid, you can simply not withdraw
from the 529 Plan until the last couple of years of college. That way, there will not likely be any
problems with the distribution of financial aid because the financial aid
office will not know about the 529 withdrawal.
Likely, though, it will not come down to that.
Recently, 529
Savings Plans have not just been considered for educational planning, but for
estate planning as well. The elderly, mainly
grandparents, have found that investing in 529 Plans can help to reduce the
taxes on their estate. As stated by
Brian Orol, a Certified Financial Planner based in Raleigh, North Carolina,
“contributions to 529 Plans can take a large amount of your taxable estate.”[18] Basically, when you contribute money into a
529 account, it is no longer considered as part of your estate. There are many rules governing how you can
put money into the 529 accounts to make the contributions work best for estate
planning. As an individual investing in
a 529, you can take up to $50,000 at one time and put it into the 529 account;
meanwhile, for a married couple, that number doubles to $100,000. Many people do not understand how this can
be done without being taxed, though, since any gifts over $10,000 are
traditionally taxed at the giver’s tax rate.
Essentially, the $50,000 contribution to the account is thought of as
five equal gifts of $10,000 each. So,
that one investment of $50,000 covers the investments for the next five
years. This is how the investment in
the 529 that exceeds the annual gift allowance avoids taxes altogether.[19]
The 529 Plan is
a very useful tool for grandparents.
Not only do the grandparents enjoy the benefits of tax-free estate
planning, but also the grandchildren benefit as well by being beneficiaries of
the accounts. Since more and more
grandparents and elderly people are using 529 Plans as a tool for estate
planning, though, the issue of a death prior to withdrawal must be addressed.
Unfortunately, only the years that the grandparent is living are tax-free. For
instance, if there is a death three years after the contribution of $50,000,
only the three years in which the investor was living will be tax-free; the
other two will be taxed at the proper estate tax rate. Investing in 529 Plans is a great way for
elderly people to avoid the troublesome estate tax altogether. As will be talked about later, since the money
is not in the name of the beneficiary, the investor retains possession of the
investment until a withdrawal has occurred.
When parents or
grandparents begin looking into investing in a 529 Plan, there are many
important things to think about.
Parents need to be sure that they have examined all of their
options. Since there are so many Plans
out there, there is much research that must be done in order to realize which
Plan best suits the needs of yourself and your family.
There are many
options when you are looking into investing in a 529 Plan. 529 Plans are offered by nearly every state
and, as you can imagine, every state’s Plan is a little bit different. Parents should know that they need to look
at more than just their own state’s Plan.
Since all plans differ, there could be better ones out there than the
one of the state in which you live. For
example, the state of Wisconsin offers a Plan entitled “Tomorrow’s Scholar
College Savings Plan.” Many parents
like this Plan because of its generous limit on investments and its low minimum
contribution limit.[21] Also, states such as Michigan have very
strict penalties for unauthorized withdrawals.
It is important to look at all the differences before deciding on one
Plan. It is important to remember,
though, that your home state most likely has the most interest in you.[22] For example, the state of Michigan offers a
matching program for lower income families with young children under which the
state contributes one dollar for every three dollars invested by the family. Only Michigan residents are eligible for
this benefit, though. This shows the lengths to which states go to retain
in-state investors.[23]
In addition to
examining the Plans offered by many different states, parents need to know that
there are two different types of Plans that are offered, as previously
mentioned: prepaid college tuition plans and college saving plans. The difference between the two is
simple. A prepaid tuition program
allows parents to simply prepay tuition many years in advance. Obviously, this sounds like a great
idea. Since experts predict that the
inflation of college tuition will take the price of a four year university well
over $250,000 in 20 years, parents can enjoy the ability to pay the average
$112,000 right now and avoid the inflation factor all together. While this Plan sounds great though, it does
have some drawbacks.[24] For example, most of the offered prepaid
tuition programs only cover the cost of tuition if your child chooses to go to
an in-state public college or university.
So, if your child decides that he or she wants to attend college outside
of the state or wants to attend a private university, then the price of their
tuition will not be covered by this plan.
This is a major drawback since no parent can know where their child will
attend college 20 years in advance. The
other plan offered by 529’s is the College Savings Plan, which has already been
discussed in great depth to this point.
With the College Savings Plan, your money is invested, usually in mutual
funds, and is allowed to grow tax-free until the point in which you wish to
take it out. This is the method that is
preferred by most Financial professionals.
Many times, when
deciding when and how to invest for their children’s education, parents wonder
whether or not they should use a broker.
This is a decision that must be made after looking over your
options. A broker can be a valuable
resource since they can offer you more investment opportunities and better
investment advice. Parents must be
aware, though, that a broker is only authorized to sell the Plan of the state
in which he or she works. Obviously,
the broker will steer the investors in the direction of their home state’s
Plan. If, however, you already know
that you want to invest in a certain state, then you can contact a broker from
that state. Additionally, brokers do charge commission, so you will be charged
extra when investing in a plan.[25] After deciding on the possible use of a
broker, parents need to also think about the investment expenses. This could actually have a great impact on
your decision about which state to invest in.
Some plans have added expense such as Arizona’s 2% technology fee.[26] This fee provides the saving plan with
current technology and is collected by Plan advisors. These little fees can add up and actually erase nearly all of the
gains made on your investment.
When deciding
whether or not to invest in a 529 Plan, parents often come across the problem
of determining where to get the information necessary for initially starting a
Plan. Luckily, though, there are many
sources of information out there to help get parents started with the college
saving process. As mentioned above,
brokers can be a good source of information that might not otherwise be
found. Again, however, their fees can
be large. The easiest way for parents
to get a hold of information regarding these Plans is to simply do a little
research. There are plenty of
worthwhile websites out there that offer an abundance of information. Additionally, many investment firms are
willing to put together a package containing all of the information they have
on 529’s. Since they are eager to get
people to invest with them, they will give you an abundance of information with
the hope that you will invest using their firm.
Another
important piece of information that parents need to know when deciding on 529
is how much money to place in the account.
When opening a savings plan, though, parents should place as much as
they can without jeopardizing the investments into their 401(k) or their
IRA. Many financial advisors urge
parents to not forget that saving for retirement is still the most important
thing to think about. Also, the tax
benefits of saving for retirement through IRAs or 410(k)s are extremely
beneficial. Most likely, 529 Plans
should receive the money that might otherwise go towards savings bonds, early
home mortgages, and other investments.[27] From state to state, there are differences
in how much investors can put into the savings plan. Usually, the minimum contribution needed to start a Plan is
around $250 dollars. Recently, many
states have begun raising their maximum total contributions. Now, the average contribution limit has
skyrocketed to around $220,000 with many states exceeding this number. This gives parents the opportunity to save
for nearly 100% of their children’s college tuition by the time the child
reaches college age.[28]
Although many of
the advantages and disadvantages of 529 plans have already been discussed, it
is worth going over them once again.
Essentially, we cannot decipher which advantage of 529 Plans has the
greatest impact on parents’ decision to invest. They are all very important.
First, 529 Plans can be used anywhere in the United States at nearly any
college or university.[29] Although the prepaid tuition program does
impose some regulations that prevent the child from attending a college or
university outside of their home state, the savings plan does not have any of
these limitations. The money in the
savings plan can be used at any qualified university or college within the
United States. And yes, nearly all
colleges and universities are qualified.
Furthermore, the
fact that there are no income limits on 529 Plans presents many parents with a
huge advantage. While many other
education savings plans, such as education IRAs, limit investing parents to a
certain income, 529 College Savings Plans do not. This, as previously mentioned, allows even the more wealthy
parents to invest for their children’s education. Additionally, the high contribution limit provides parents with a
much greater opportunity to save a larger amount of money. With the traditional Education IRA, parents
can only invest up to $3000 per year into the plan. This limits the ability of many parents to save a proper amount
for their children’s education. With
the 529, parents can invest more than $200,000.[30] Using the Education IRA, it would take
parents more than 66 years to reach $200,000, and think of how much compounded
interest would be wasted. The fact that
parents can easily change the beneficiary presents yet another advantage of the
Plan. If a child decides that he or she
no longer wishes to attend upper level education, then the parents can simply
switch the beneficiary of the plan. For
parents who have several children, they can simply name a younger child as the
primary beneficiary after the elder finishes college. This benefit provides for the lack of the ability to name
multiple beneficiaries for the same plan. It helps to put many parents’ minds
at ease. They do not have to worry
about the possibility that much of their hard earned money will be wasted.
Much like the way in which money is invested
in 401(k) Plans, so too can money earned in the workplace be directly deposited
into a 529 Savings Plan. This provides
many parents with a carefree way to invest.
They do not have to worry from month to month or from year to year how
much they want to invest or when they want to invest. They simply sit back and let the corporation for which they work
take automatic payroll deductions that are invested in the plan.[31]
While many
parents choose to invest in a custodial account, using the Uniform Gift to Minors
Act as their guide, others prefer the 529 for its possession
benefits. With custodial accounts, the
money is turned over to the child after the child turns 18 years of age. However, with the 529 Savings Plan, the
money remains in the hands of the parents, even after the child reaches legal
age. This is usually one of the more
important advantages that parents want in the 529’s. Some parents worry that their child will “take the money and run”
after they turn 18. With the 529
Savings Plan, though, they will not be allowed to do that.
Many parents,
however, do not like the fact that a Plan Administrator handles the money that
they invest in the Plan. Parents often
want to be in complete control of their money but, when using a 529, they are not. The money is in their name, but a Plan
Administrator is the one who oversees all of the activity within the 529 Plans.[32]
Obviously,
another disadvantage of the Plan is the withdrawal penalty that investors pay
when they take out their money for non-qualified purposes. The average penalty tax for non-qualified
withdrawals is around 10%.[33] If, however, parents are sure that they want
this money to go towards education of some sort, even if it is not for their
own child, then they do not need to worry about this fee. They can simply invest in the Plan and watch
their money grow.
While there are
some disadvantages to the Plans, the advantages more than outweigh the
disadvantages. There are some downsides
to every form of investing but, luckily, the downside to 529 is very
insignificant.
Just three years
ago, the face of 529 Plans looked very different. In the past three years, however, there have been many
changes. One of the greatest things to
happen to 529’s was the new tax treatment effective on January 1, 2002.[34] This has allowed the money invested in the
Plans to grow tax-deferred. So, after
this change has taken place, where is the Plan going from here? Nobody knows for sure. One thing is sure, though. With the ruthless competition between states
and the ever-changing face of the investment trade, 529 Plans have nowhere to
go but up. They will continue to
improve for many years to come. Does
this mean that parents should wait for these improvements and advancements to
invest in 529’s? Absolutely not! It is definitely in the best interest of
parents to invest as soon as possible.
This will let their money grow to its maximum potential.
Again, it is
important to note that every state is different when it comes to their
respective 529 Plan. For instance, the
state of Wisconsin allows parents to invest up to $246,000 while the state of
Washington only allows parents to invest just over $20,000. Additionally, the state of North Carolina
penalizes investors 15% for unauthorized withdrawals while the state of
Michigan does not even allow you to withdraw your money. [35]
Obviously, due to the strong competition between states, investors should look to
their home state first, but it can pay off to look beyond the borders of the
state in which you live.
The state of
Nebraska is a great state in which to begin your 529 investing. Although it only offers a savings type plan
and not a prepaid tuition program, it is open to nonresidents and you are
allowed a deduction for contributions up to $1,000 per year. So, parents are allowed to take full
advantage of the rare tax deduction benefit.
Additionally, while there is a penalty on unauthorized withdrawals from
the plan, the penalty is one of the lowest in the country at only 10%. In Nebraska, parents can invest as little as
$300 to start, or simply $25 per month, or as much as $165,000. Although this is not as high as the $246,000
maximum limit in Wisconsin, it more than does the job. Finally, when looking at different
investment choices from state to state, it is very rare to find a state that
offers the investor ten different choices.
Nebraska, however, gives the investor 10 options that use funds from
Fidelity, T. Rowe Price, and Vanguard and even includes an S&P Index fund
as an option. Four of these funds are
age-based, which bases the arrangements of the investment on the age of the
child. With this age-based option,
parents can choose to invest as much as 80-100% in common stock until the child
reaches age ten. The only expense
involved with these funds is a $24 annual maintenance fee. Obviously, Nebraska is a very attractive
choice. In the appendix of this paper
is a chart containing a state-by-state comparison of other Midwest states and
their 529 Plans. [36]
The Coverdell
Education Savings Account, formerly known as the Education IRA, was renamed in
2002 and is a very attractive college savings vehicle for many people,
especially for families that wish to save for elementary and secondary school
expenses. With the rising cost of
college education, a Coverdell Education Savings Account is a great way to help
finance a child’s future education costs.
The Coverdell is an investment vehicle targeted to education expenses,
not to retirement.
There are
several guidelines that must be followed in order to be eligible to contribute
to a Coverdell Education Savings Account.
In order to be eligible for a Coverdell, the contributor must be a
family member. A qualifying family
member is any family member with direct relation to the creator, such as a
grandchild or a niece.[37]
Full contribution
to an Education Savings Account is allowed apart from contributions to
Traditional IRAs, Roth IRAs, and employer-sponsored plans. In 2001 the contribution level for an
Education Savings Account was $500 per child and was increased in 2002 to
$2000. If a contribution for a child
exceeds the $2000 a year limit then there will be a 6%[38]
excise tax penalty assessed. A
contributor can eliminate the penalty by withdrawing the excess contributions
before the due date of the beneficiary’s tax return for that year. The contribution that is made into the
Coverdell account will eventually go to the child if the money is not used for
college. Unlike 529 plans, Coverdell
accounts do not refund the money back to the investor, which means that the
investor loses some degree of control.
With a Coverdell account, the trustee must administer the account for
the benefit of the child. Any
withdrawals from the Coverdell account are paid to the beneficiary and are not
refunded to the parent. The Coverdell
education savings account can be a disadvantage when applying for financial aid
since the account is considered an asset of the student, not the parent.
The Coverdell
education savings account must fully be withdrawn by the time the beneficiary
reaches age 30, or else it will be subject to tax on the earnings and the
additional 10% penalty tax. [39] If the beneficiary should happen to die
before the age of 30, the account will be paid to the beneficiary’s estate,
unless his or her legal representative authorizes a change in beneficiary to a
surviving spouse or other family member under age 30. Coverdell Education Savings Accounts works much like a Roth
IRA. They both allow an investor to
make an annual non-deductible contribution to a specially designated investment
trust account. The account will grow
free of federal income taxes, and withdrawals from the account will also be
tax-free.
The first step
is to make sure that you are eligible to contribute to a Coverdell Education
Savings Account. The beneficiary of the
account must be under the age of 18 at the time of the contribution. Since the beneficiary is a minor at the time
the contributions are made, an adult is named as the “responsible individual.” [40] The responsible individual is generally the
parent or guardian of the beneficiary, but Grandparents and other close
relatives may also apply. The only
requirement is that the beneficiary is a family member to the contributor. To a certain extent, the responsible
individual can prevent the beneficiary from using the funds for something other
than college under the Uniform Transfers to Minors Act or the Uniform Gifts to
Minors Act. In order to be a
contributor to the Coverdell Education Savings Account, your adjusted gross
income must be less than $190,000 for married taxpayers and $95,000 for single
filers in order to qualify for a full $2,000 contribution. The $2,000 maximum is gradually phased out
if the contributor’s modified adjusted income falls between $190,000 and
$220,000 for married taxpayers or between $95,000 and $110,000 for single
filers. A contributor may contribute to
a 529 plan and a Coverdell account for the same beneficiary if desired. [41]
The next step is
to decide where to establish the Coverdell education savings account. Any bank, mutual fund company, or other
financial institution that can serve as custodian of traditional IRAs is
capable of serving as custodian of a Coverdell account. The cash contribution can be invested in any
qualifying investments available through the sponsoring institution, such as
stocks, bonds, mutual funds, and certificates of deposit. It is possible to establish several
Coverdell accounts for one child, as long as the total contribution stays
within the $2,000[42]
limit. While it is possible to create
multiple Coverdell accounts, the annual fee and custodial fee minimums make
this impractical.
The third and
final step would be to complete the Coverdell Education Savings Account
enrollment forms from the sponsor and to make the contribution. There are two main advantages to the
Coverdell education savings account.
The first advantage is that the investor can self-direct the
investments, like other IRA accounts.
529 plans are limited to mutual fund accounts offered by the plans. The second advantage of the Coverdell
education savings account is that the IRA can be used for private and religious
elementary and secondary schools, while 529 plan assets can only be used to pay
for expenses at an approved institution of higher education.
The Coverdell
education savings account has tax-free and penalty-free earnings as long as the
assets are used to pay education expenses and are withdrawn before the
beneficiary reaches the age of 30. The
beneficiary can receive tax-free withdrawals in any year to the extent that he
or she incurs qualified higher education expenses. If the beneficiary withdraws more than the amount of qualified
higher education expenses, then the earnings portion of that excess is subject
to income tax and an additional 10% penalty tax. The beneficiary may have a 529 plan and a Coverdell account and
therefore would have to allocate the available qualified higher education expenses
between the accounts. The beneficiary
may also take tax-free withdrawals for the Coverdell account to pay for certain
elementary and secondary school expenses such as, tuition, fees, tutoring,
books, supplies, and equipment needed in connection with school. This would also include any room and board,
uniforms, transportation and supplementary items that are required for
school. Finally, it includes expenses
for the purchase of computer technology, or Internet access, used by the
beneficiary and family during the years the beneficiary is in school. Qualified higher education expenses must be
reduced by any other tax-free benefits received, such as scholarships or
benefits under a qualifying employer-provided educational assistance program.[43]
Investing in 529 College Savings Plans provides investors with a wonderful opportunity to save for their children’s future education. Because of the dramatic rise in college tuitions all over the country, parents need to realize the importance of planning ahead for the betterment of their children and their children’s education. 529 College Savings Plans are a better alternative for investors. Traditionally, investors have been left to invest solely in stocks, bonds, CD’s, and IRAs. Now, though, parents can plan exactly what is needed for their child’s education, including books, tuition, and fees. Moreover, the information is laid out in a clear manner that allows all investors, both experienced and inexperienced, to enjoy the benefits of early future planning. While there are other ways to save for college, such as the Coverdell Education Savings Account, investing in a 529 Plan offers the best opportunity for parents to achieve their educational goals.
Beneficiary- An individual, institution, trustee, or estate
which receives, or may become eligible
to receive, benefits under a will, insurance policy, retirement plan,
annuity, trust,
or other contract.
Capital gains- The amount by which an asset's selling price exceeds its
initial purchase price. A
realized capital
gain is an investment that has been sold at a profit. An unrealized
capital gain is
an investment that hasn't been sold yet but would result in a profit
if sold.
Series-I Savings Bond- a savings
account much like 529s, although the funds that are
withdrawn can only be used for tuition, not
for all the expenses that go
along with education.
Tax-deferred - Income whose
taxes can be postponed until a later date. Examples include IRA,
401(k), Keogh Plan, annuity, Savings Bond
and Employee Stock Ownership
Plan.
Uniform Gift to Minors Act- Laws adopted by
most states allowing an adult to contribute to a
custodial account in a minor's name without
having to establish a
Antman, Less
C.P.A. “College Cash.” http://www.harvardmagazine.com/on-line/110163.html.
February 22, 2002.
AuWerter,
Stephanie. “The 529 Basics.” http://www.smartmoney.com/consumer/index.cfm?Story=200106083.
February 22, 2002.
Balcells-Baldwin, Lisanne. "I've made a macro!...now, how do I
get it to run?"
http://www.hal-pc.org/journal/jan97/01excel.html. February 10, 2002
Buckner, Gail
CFP. “Great News on Gifting and Two
Ways to Save for Education Expenses.” http://www.foxnews.com/story/0,2933,38947,00.html.
February 22, 2002.
Block,
Sandra. “College 529 Plans Raise
Contribution Limits.” http://www.usatoday.com/ustonline/20020121/3789432s.htm
“Coverdell
Education Savings Account.” http://business.firstunion.com/tax_center/0,3461,2953_3126,00.html. March 19, 2002.
Hurley,
Joseph. “The Big News About College
Savings.” http://www.mutual-funds.com/mfmag/stories/2001/august/college_savings.html.
February 22, 2002.
Hurley,
Joseph. www.savingforcollege.com. March 1, 2002.
“Internet Guide
To Coverdell Savings Account.” http://www.savingforcollege.com/coverdell/faqs/1.php. March 19, 2002.
Kiplinger. “State College Savings Plans.” http://kiplinger.com/tools/managing/college/savings/2001/states01.html. February 22, 2002
Kiplinger. “Nebraska.”
http://www.kiplinger.com/tools/managing/college/savings/2001/NE.htm. February 22, 2002
Lankford, Kim.
“Grade the College Savings Plan.” http://www.kiplinger.com/columns/ask/archive/2002/q0109.htm.
February 22, 2002.
Lauricella,
Tom. “Some College Savings Plans, Done
At Work, Miss Tax Perks.” The Wall Street Journal. April 4, 2002. p. C1
Lewis, Roy. “A
Tax-Smart Way to Save for College.” http://www.fool.com/taxes/2002/taxes020111.htm.
February 22, 2002.
Ma, Jennifer and
Fore, Douglas. “Saving For College With
529 Plans and Other Options: An Update.”
Research Dialogue, American Express
Max, Sarah. “The
pros and cons of 529s.” http://money.cnn.com/2001/10/15/college/q_college/.
February 22, 2002.
Porzelt,
Paula. “Freshman Tuition Jumps
Again.” The Creightonian. March 22, 2002
Rowell, Marge.
“Creating Macros in Excel.” http://www.wellesley.edu/Computing/Excel97/macro.html.
February 10, 2002
Tergesen, Anne.
“Saving for College Will Yield Smarter Returns.” http://www.businessweek.com/magazine/content/02_04/b3767604.htm.
February 22, 2002.
“Tomorrow’s
Scholar College Savings Plan.” Strong and American Express Pamphlet, American
Express. March 19, 2002.
Weinreich, Gil.
“529 A Progress Report.” Research
http://www.researchmag.com/articles/pdf/rb02_01.pdf.
February 22, 2002.
http://www.collegesavings.org/federal_initiatives.htm
http://www.529collegeinvesting.com
February 22, 2002.
http://www.cs.helsinki.fi/research/aaps/excel/#cs
“Computer Science Visualizations”
February 10,
2001
Appendix 1
Midwest
State-by-State Comparison
|
State
|
Tax Deductions |
Open to Nonresidents and Refund Provisions |
Minimum
and Maximum
Contributions |
Other
|
|
Iowa
|
Deductions
for contributions up to $2,112 per beneficiary each year |
Open
to all nonresidents Carries
a 10% penalty for unauthorized withdrawal |
Minimum
contribution of $50 and a maximum contribution of $146,000 |
Offers
4 customized age-tailored options that invest in up to 5 portfolios managed
by The Vanguard Group |
|
Kansas |
Deductions
for contributions up to $2,000 per beneficiary per year ($4,000 if married
filing jointly) |
Open
to all nonresidents Carries
a 10% penalty for unauthorized withdrawal |
Minimum
contribution of $500 for residents and $2,500 for nonresidents and a maximum
Contribution of $235,000 |
There
is a two-year wait before you can make any withdrawals, although legislation
is pending to remove the wait |
|
Minnesota |
No
state tax deductions for residents or nonresidents |
Open
to all nonresidents Carries
a 10% penalty for unauthorized withdrawal |
Minimum
contribution of $25 and a maximum contribution of $122,484 |
Families
with income of less than $50,000 are eligible for a 15% matching grant on
contributions of at least $200 per year |
|
Missouri |
Deductions
for contributions up to $8,000 per year ($16,000 for couples) |
Open
to all nonresidents Carries
a 10% penalty for unauthorized withdrawal |
Minimum
contribution of $25 and a maximum contribution of $235,000 |
You
must wait one year to make withdrawals, total expenses are only .65% per year |
Nebraska
|
Deductions for contributions up to $1,000 per year |
Open
to all nonresidents Carries
a 10% penalty for unauthorized withdrawal |
Minimum
contribution of $300 ($25 per month) and a maximum contribution of $250,000 |
Ten investment choices, four age-based portfolios and six other
options |
|
Wisconsin
|
Deductions
for contributions of up to $3,000 per child per year |
Open
to all nonresidents Carries
a 10% penalty for unauthorized withdrawal |
Minimum
contribution of $250 and a maximum contribution of $246,000 |
Wisconsin's plan, managed by Strong Capital Management, offers
six investment options |
Source:
http://kiplinger.com/tools/managing/college/savings/2001/states01.html
|
Money |
Tax Implications |
|
Initial investment |
-
The initial investment must be made
with after-federal tax income. -
It should be made with before-state tax income
due to the advantages of in-state investing. |
|
Earnings during investment period |
-
All earnings received during the life
of the investment are accrued tax-free from both state and federal taxes. |
|
Withdrawal of earnings and initial investment |
-
The withdrawal of earnings may be taken
out completely tax-free, provided guidelines are followed. Guidelines vary from state to state, but
all insist that funds must be used for educational purposes. |
[1] Ma
[2] Porzelt.
[3] Lewis
[4] Antman
[5] op. cit. Ma
[6] op. cit. Ma
[7] Buckner
[8] Refer to Appendix 2
[9] op. cit. Ma
[10] Refer to the following section “Transferability”
[11] op. cit. Buckner
[12] Tergesen
[13] Hurley. February 22, 2002
[14] Many states, when determining whether or not an individual is able to receive financial aid and state loans, take into account the fact that the individual owns a 529 Plan. Some states, though, as an effort to attract in-state investors, have offered to ignore the fact that the individual owns a 529 Plan when determining the ability to receive financial aid and state loans.
[15] op.cit. Hurley
[16] Max
[17] ibid
[18] ibid
[19] ibid
[20] “Tomorrow’s Scholar College Savings Plan”.
[21] op. cit. Tergesen
[22] Usually, a state will want to keep its residents from investing in other state’s Plans. Because of this, your home state will usually offer deals and tax breaks that a different state will not.
[23] Lauricella
[24] Auwerter
[25] op. cit. Ma
[26] op. cit. Hurley. February 22, 2002
[27] op. cit. Ma
[28] Block
[29] op. cit. Lankford
[30] op. cit. Lewis
[31] op. cit. Antman
[32] op. cit. Lewis
[33] op. cit. Ma
[34] op. cit. Antman
[35] Kiplinger. “State College Savings Plans.”
[36] Kiplinger. “Nebraska.”
[37] “Coverdell Education Savings Account.”
[38] “Internet Guide To…”
[39] ibid
[40] ibid
[41] ibid
[42] ibid
[43] ibid