A child born today can expect to pay approximately $245,000 to attend a private college and $113,000 to receive a degree from a public university.
It's hard to contest the value of a postsecondary degree. The amount of education you complete often directly affects your future earnings. The more schooling you complete, the higher your potential earnings. According to U.S. census data, people who obtain a vocational degree will earn approximately 25 percent more than those who earn only a high school diploma. What's more — those who earn a bachelor's degree will, on average, have incomes of 44 percent more (and those who possess a master's degree will earn as much as 56 percent more) than a high school graduate (U.S. Census Bureau, 1999). Over a lifetime, this gap in earnings potential between a high school diploma and a bachelor's degree is more than $1 million. The latter statistic was reported in College Board Trends in College Pricing 2000. The case is clear: Obtaining a college or other postsecondary degree can be critically important to meeting your life's goals.
However, while many people may understand the value of a higher-education degree, too often they do not understand the value of planning early to meet the financial demand it requires. In fact, according to College Board, many people do not save as much as they need for college. The cost of college is only rising. A child born today can expect to pay approximately $245,000 to attend a private college and $113,000 to receive a degree from a public university (U.S. Census Bureau, 1999). For the majority of people saving to send their children, grandchildren, themselves, or others they love to college, that expense can be difficult to meet. If this is the case, why don't people begin to save years before they need the money?
Perhaps it is the misconception that they have plenty of time to save. Or, perhaps, knowing the cost of schooling is so high, people choose not to think about it. Whatever the case may be, the importance of saving for advanced degrees has never before been so great. Thanks to the birth of 529 plans, saving has become much simpler and more tax-efficient.
A 529 plan and how it works
Introduced in 1996, 529 plans, which are named after the section of the federal tax code that governs them, are college savings plans that enable anyone to open an account and invest significant amounts for college expenses (contribution limits vary from state to state). Investments in 529 plans grow federal income tax-deferred until withdrawal.
Beginning in 2002, when assets are withdrawn for qualified higher-education expenses — such as tuition and qualified room and board expenses — the earnings will be federal income tax-free. However, keep it in the back of your mind that the federal treatment of qualified 529 plan withdrawals is scheduled to expire after Dec. 31, 2010, unless extended by Congress.
Benefits of 529 plans
The information below is based on current tax laws, regulations, rules, and interpretations, which are subject to change at any time. Many significant changes to 529 plans were made by the Economic Growth and Tax Relief Reconciliation Act of 2001. Most of the changes became effective on Jan. 1, 2002, and are scheduled to expire on Dec. 31, 2010, unless extended by Congress. Final regulations implementing the changes may impact eligibility for and limitations associated with 529 plans. Please consult your tax adviser regarding the tax consequences of your contributions to and withdrawals from any 529 plan.
No income restrictions — One of the biggest advantages of 529 plans is that there are no income restrictions. That makes a 529 plan a powerful college-funding vehicle for virtually everyone.
High contribution limits — Contribution limits in most states are more than $150,000 per beneficiary. With the cost of college rising every year, high contribution limits better position investors to meet those rising costs.
Broad eligibility — Anyone (parents, grandparents, friends, self) can establish a 529 account, and anyone can contribute to the account once it is established. Qualified expenses can include tuition, room and board, supplies, etc., in connection with attendance at an eligible institution. More than 8,000 schools — including colleges, universities, community colleges, and technical/vocational schools — currently qualify as eligible institutions. These factors, which offer choices to contributors and those attending college, make 529 plans convenient and attractive.
Planholder control — As a 529 account owner, you can determine how your investment is used. If you are the registered account owner and your child does not attend college, you may change beneficiaries (There may be federal gift- or generation-skipping transfer tax consequences if the new beneficiary is a member of a lower generation than the prior beneficiary.) or withdraw the assets you have accumulated.
Please note that nonqualified withdrawals are subject to taxation and penalties. Beginning in 2002, the earnings portion of any nonqualified withdrawals (i.e., generally those not used for qualified higher-education expenses) will be subject to a 10 percent penalty.
The state of Arizona currently imposes a similar 10 percent penalty. It is anticipated that the Arizona legislature will repeal Arizona's 10 percent penalty for withdrawals made after Dec. 31, 2001, but there can be no assurance that the penalty will be repealed. Until it's repealed, Arizona's penalty will generally be withheld at the time of any nonqualified withdrawal. Beginning in 2002, the federal penalty will apply in the form of an additional 10 percent tax on the earnings portion of any nonqualified withdrawal.
Tax Advantages — Earnings in 529 plans grow federal income tax-deferred, enabling your account to grow faster than a comparable taxable account. Also, beginning in 2002, withdrawals are federal income tax-free if used for qualified higher-education expenses.
• There also are potential federal gift and estate tax benefits for contributions to a 529 plan. Such contributions are treated as completed gifts to the beneficiary. As a result, the contributions and any earnings in the account generally are not included in the estate of the contributor. Through the use of the annual $10,000 gift-tax exclusion ($20,000 in the case of a married couple), it is possible to contribute substantial amounts to an account without incurring any gift tax.
An election can be made (on the federal gift-tax return) to spread up to $50,000 of a contribution to a 529 plan over five years. (If the contributor dies before the end of the five-year period, the portion of the gift allocable to the years remaining in the five-year period would be in the contributor's estate for federal estate-tax purposes.) Thus, a lump sum contribution of $50,000 generally may be made by each donor ($100,000 in the case of a married couple) to a 529 plan on behalf of each beneficiary without any gift-tax consequences (assuming the donor makes no other gifts to the same beneficiary in the five-year period).
Although additional contributions also may be made (subject to contribution limitations under the plan) by a contributor that exceed the annual gift-tax exclusion (including the five-year election), such contributions may, depending upon the circumstances, result in gift-, estate-, or generation-skipping tax consequences to the contributor.
• 529 plans offer special advantages for estate-planning purposes. Subject to certain limitations, contributions to a 529 plan generally are excluded from your taxable estate for federal estate-tax purposes, provided you are not also the beneficiary on the account.
• Use of Hope Scholarships and Lifetime Learning Credits will not affect participation in or the receipt of benefits from a 529 plan. Similarly, contributions to a 529 plan will not affect your use of or receipt of benefits from a Hope Scholarship or Lifetime Learning Credit. For years after 2001, the total amount of qualified higher-education expenses in a year is reduced by the amount of expenses taken into account in determining any allowable Hope Scholarship and Lifetime Learning Credits.
As you can see, 529 plans can potentially enable you to save more money in a tax-advantaged way than other college-savings vehicles, while enabling you to maintain control of withdrawals from the account. What's more, they provide tax advantages equal to — or better than — those available from any other college-savings vehicle. We believe no college-savings vehicle provides as powerful a combination of benefits as do 529 plans.
Kathleen Adams, RDH, BS, is a financial adviser with Waddell and Reed (www.waddell.com). She is currently trying to initiate money-management workshops for hygiene students and specializes in working with dental professionals. She can be reached at (800) 210-1357.