With the rising cost of college tuition, many parents and grandparents are concerned about their ability to pay for their children's or grandchildren's education. Let's face it - college is very expensive!!

A 529 college savings plan is a great savings vehicle for this purpose, and it has multiple benefits.

The most popular features include income tax benefits, estate tax benefits, and flexibility with regards to both contributions and the use of the plan funds. 

Probably the most appealing benefit of the 529 plan is the potential tax savings.

The beneficiary may be able to take qulified distributions federal-income-tax-free. In other words, the earnings on the plan are not taxed if the plan is used properly.

Most states sponsor their own 529 plan and if you participate in your state's plan, you may also enjoy a state tax deduction on contributons and state-tax-fear withdrawals. Check with your tax advisor however, to determine the tax treatment of distributions in your state. 

There are certainly other advantages of 529 plans also.

* Contributions can be lump sum or set up on a systematic basis providing you with flexibility based upon your circumstances.

* The account owner (which is usually the parent or grandparent) retains control of the plan assets and can change beneficiaries to another qualified family member of the original beneficiary at any time without triggering any income tax consequences. 

* There are no income limitations for participation in the plan, which is a great benefit for higher-income families.

* There are also significant estate-planning benefits of 529 plans. Due to a special 5-year accelerated gift provision unique to 529 plans, a single person can contribute up to $85,000 in on year per beneficiary and a married couple can contribute up to $170,000 in one year per beneficiary with no gift-tax consequences. No additional gifts can be made however for that beneficiary for the current year and the next four years without creating gift-tax implications. So not only are you able to jump start your education savings, but this accelerated gifting technique also allows you to reduce your taxable estate.

So how is the plan used? 

The beneficiary of a 529 account can use the plan balances at any eligible educational institution in the United States or certain schools abroad for qualified expenses. In some states, even qualified elementary and secondary education expenses can be paid for up to $10,000 per year per beneficiary, but for tuition only.

Qualified higher education expenses include tuition, fees, books, computer equipment, and supplies required for enrollment or attendance at the eligible institution or for registered apprenticeship programs. Room and board are also qualified expenses for students who are at least half time, both for on and off campus housing. Qualified expenses also include qualified student loan repayments for the beneficiary or siblings (up to $10,000 lifetime each, not annual).

You do not need to include your expense receipts with your tax return but save them with your records as the IRS may request them later.

Clients often ask, "What happens if the funds are not used for qualified education expenses?" 

Withdrawals from a 529 plan are separated into two components: an "earnings" portion and a "return of your investment" portion. The return of your investment portion is never subjected to federal income tax. However, if a withdrawal is not used for qualified educational expenses, the earnings portion of the withdrawals is subject to income tax and a potential 10% additional tax with some exceptions. 

The distribution from the 529 plan to pay for a qualified expense can be paid directly to the school of to the student or account owner as reimbursement of an expense already paid as long as both the distribution and the payment of the expense occur in the same tax year. 

We hope this provides you with a basic knowledge of 529 plans. However, you may still have many more questions. Please reach out to us to discuss your unique situation. As always, Pharos Financial Advisors welcomes the opportunity to work with you to help you achieve your financial goals.