of mind knowing that the money that was set aside for college won’t go to fund something else. Plus, with the advantage of being able to change the beneficiary, you ensure that the college money will be used for college. It may just be that the original intended recipient is not the one who winds up using it!
529s also benefited from the government’s recent tax law change. As of January of 2002, any qualified withdrawal will now be com- pletely tax-free for federal income tax purposes.* The withdrawals have been tax-free from state income taxes in some cases. All contributions are made on an after-tax basis; thus, they cannot be deducted. As with the education IRA, the new tax law again coordinates the benefits of the 529 tax-free withdrawals with the HOPE and Lifelong Learning credits so that the distribution from the 529 cannot be used for the same expenses for which the credits are being claimed. Plus, you can now make contributions to both an education IRA and a 529 plan for the same person in the same year. Under the old tax law, this was prohibited.
Section 529 plans now exist in all states. Any resident of any state may invest in a 529 plan from any other state. There are also no lim- itations on the type of university the funds can be used for. There are state-assisted tuition programs that parents can invest in, which we won’t be discussing, that specify that the funds may only be used for in-state colleges and universities. With the 529s, there are no such limitations. Therefore, a child in California whose parents have used the 529 plan to save for college may use the money when the child attends college in Texas, and so on.
529s also allow greater flexibility in the amount of money that can be saved. The limit for education IRAs is $2000 per year. 529 plans don’t have a limit on the amount that can be contributed per year. In fact, the tax laws allow for an individual to give up to $55,000 in one year to the beneficiary of a 529 plan without triggering any gift tax. The catch to this, though, is that the gifting individual cannot give any more money to that beneficiary for the next five years. Essentially, the $55,000 is the gift of $11,000 for five years made all at one time. For married couples, the maximum gift would be $110,000.
*The Economic Growth and Tax Relief Reconciliation Act of 2001 is scheduled to “sunset” effective 12/31/2010. Following 12/31/2010, qualified distributions from 529 plans may be taxable. Individuals contributing on behalf of someone who will be attending a higher edu- cation institution after 2010 should consider this potential impact.