OVERVIEW OF SECTION 529 PLANS

    In the knowledge-based economy of the 21st century, pursuing some kind of post-secondary education, whether in a traditional college setting or at a technical, business, or vocational school, will be essential.  Affording the costs of such education, however, will remain a challenge for families at almost all income levels, since the costs of higher education have consistently risen faster than inflation and family income.

    Responding to this situation, in 1996 Congress added Section 529 to the Internal Revenue Code in order to grant tax-exempt status to qualified state tuition programs.  Section 529 has been amended several times since then, most recently by the Economic Growth and Tax Relief Reconciliation Act of 2001 ("EGTRRA") and the Pension Protection Act of 2006, which made certain tax benefits permanent.

    Especially in light of the statutes, it is safe to predict that for many families Section 529 Plans will become the preferred method of providing for their children’s and grandchildren’s higher education.

    There are now three types of Section 529 Plans available: 

Each of these three plans is explained in the section titled "Setting Up a Section 529 Account."

    The purpose of each type of Section 529 plan is to provide for the:

         "Qualified Higher Education Expenses" of a

            "Designated Beneficiary" at an

          "Eligible Educational Institution."

     These terms are defined below.

QUALIFIED HIGHER EDUCATION EXPENSES includes tuition, fees, books, supplies, and equipment required for the enrollment or attendance of a designated beneficiary at an eligible educational institution.

Special Needs Services. "Qualified higher education expenses" includes expenses for special needs services in the case of a special needs beneficiary that are incurred in connection with such enrollment or attendance.

Room and Board Costs. "Qualified higher education expenses" also includes reasonable costs incurred by the designated beneficiary for room and board while attending an eligible educational institution as at least a half-time student.

Such costs cannot exceed (1) the allowance applicable to students residing off-campus for room and board included in the "cost of attendance," as determined by the eligible educational institution for such period, or (2) if greater, the actual invoice amount for room and board that students are charged for such period by the eligible educational institution when they are residing on campus or in other housing owned or operated by such institution.

 

DESIGNATED BENEFICIARY means:

The initial individual designated at the time participation begins in the Section 529 Plan.

If the beneficiaries are later changed, the individual who is designated as the new beneficiary.

The individual receiving the benefits accumulated in the account as a scholarship in the case of certain Section 529 Plan accounts.

ELIGIBLE EDUCATIONAL INSTITUTION. The third requirement for Section 529 qualification is that the designated beneficiary must be enrolled at or attending an "eligible educational institution," which refers to an accredited post-secondary educational institution offering credit toward a bachelor's degree, an associate's degree, a graduate level or professional degree, or another recognized post-secondary credential. Certain proprietary institutions and post-secondary vocational institutions also are eligible institutions. (Generally, the institution must be eligible to participate in Department of Education student aid programs.)

To determine if a particular institution is an "eligible educational institution," check the U. S. Department of Education's web site at -- http://www.fafsa.ed.gov/fotw0506/fslookup.htm

Elementary and Secondary Education Not Covered. From the above discussion, it is clear that Section 529 Plans cannot properly be used to pay for the costs of a student’s elementary or secondary (high school) education. As an alternative, parents or others wanting to invest funds for purposes of covering the costs of a student's elementary or secondary education can create a Coverdell Education Savings Account.

OTHER REQUIREMENTS OF SECTION 529 PLANS

Section 529 imposes several other requirements that are applicable to both Prepaid Tuition Plans and Education Savings Plans. The two most important are the following:

A Section 529 Plan can only accept contributions in the form of cash. Some state programs have expanded the definition of "cash" to allow payment by check, money order, credit card, or similar methods; other states also permit contributions to be made by payroll deductions or automatic withdrawals from a bank account.

Some Section 529 Plans also permit certain U.S. Savings Bonds to be redeemed and deposited tax-free into the account, subject to compliance with the education tax exclusion rules, as described in 26 U.S.C. § 135.

A Section 529 Plan must provide that any contributor to, or designated beneficiary under, the Section 529 Plan may not directly or indirectly direct the investment of any contributions to the program, or any earnings thereon. However, a program may permit a person who establishes an account to select among different investment strategies designed exclusively by the program.

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DISCLAIMER

Martin J. Hagan is licensed to practice law in the Commonwealth of Pennsylvania. This website is intended solely for informational use and is not intended to solicit clients. Likewise, any information contained in or obtained from this web site is for informational purposes only and is not intended to be used as legal advice.

IRS CIRCULAR 230 DISCLAIMER:   Pursuant to Treasury guidelines, any tax advice contained in this website (or any link from it) does not constitute a formal opinion. Accordingly, any tax advice contained in this website (or any link from it) is not intended or written to be used, and cannot be used by any taxpayer, for the purpose of avoiding penalties that may be asserted by the Internal Revenue Service. You should seek advice based on your particular circumstances from an independent tax advisor.

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Copyright © 2008 Martin J. Hagan, One Gateway Center - 8 South; Pittsburgh, PA 15222-1435

Last Updated: 05/28/08