Qualified tuition programs, also known as 529 plans (named for the
Internal Revenue Code section that provides for them), allow
prepayment of higher education costs on a tax-favored basis.
There are two types of programs: prepaid plans, which allow you to buy
tuition credits or certificates at present tuition rates, even though the
beneficiary (child) won't be starting college for some time; and savings
plans, which depend on the investment performance of the fund(s) you place
your contributions in.
Taxpayers don't get a federal deduction for the contribution, but the
earnings on the account aren't taxed while the funds are in the program.
Individuals can change the beneficiary or roll over the funds in the program
to another plan for the same or a different beneficiary without tax
consequences.
Distributions from the program are tax-free if they don't exceed the
student's qualified higher education expenses. If the program was
established by a private education institution (rather than a state), the
distributions are tax-free beginning in 2004.
Qualified higher education expenses include tuition, fees, books,
supplies, and required equipment. Reasonable room and board is also a
qualified expense if the student is enrolled at least half-time.
Distributions in excess of qualified expenses are taxed to the
beneficiary to the extent that they represent earnings on the account. A 10%
penalty tax will also be imposed.
Accredited colleges, junior colleges, and area vocational schools are
qualified to participate in the tuition program. Accredited post-secondary
schools offering credit towards a bachelor's degree, an associate's degree,
a graduate or professional degree, or another recognized post-secondary
credential, are also eligible to participate, as are certain proprietary
institutions and post-secondary vocational schools.
The contributions made to the qualified tuition program are treated as
gifts to the student, but the contributions qualify for the annual gift tax
exclusion, which is $11,000 for 2005. If contributions in a year exceed the
exclusion amount, taxpayers can elect to take the contributions into account
ratably over a five-year period starting with the year of the contributions.
Thus, assuming a taxpayer makes no other gifts to a beneficiary, they could
contribute up to $55,000 for each beneficiary in 2005 without gift tax. (In
that case, any additional contributions during the next four years would be
subject to gift tax, except to the extent that the exclusion amount
increases.) A husband and wife together could contribute $110,000 per
beneficiary, subject to any contribution limits imposed by the plan.
A distribution from a qualified program isn't subject to gift tax, but a
change in beneficiary or rollover to the account of a new beneficiary is.
