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Saving for College

Sept. 29, 2019

When I first wrote my newspaper column about "saving for college" it was August, the time for many students to leave for a new year in college. It was too late for those students to start a college fund to pay tuition costs for that year. However, there is always plenty of time for parents and grandparents of younger students to save money. One of the best methods for such savings is a tax-free saving plan commonly referred to as a 529 plan.

Section 529 of the Internal Revenue Code was amended in 2001 to grant tax-free status to distributions from a Qualified State Tuition Program (QSTP). Any investment income earned on a QSTP account, if it is distributed for a qualified educational expense, is tax exempt. One feature that is easy to overlook is that there is no maximum age on who can start a 529 Account or who can be a beneficiary of an account. An adult can start an account for "later-in-life" education.

There are basically two types of QSTP: a pre-paid tuition program and a savings program. All 50 states have passed laws to establish programs to administer their respective QSTPs. Pre-paid tuition programs are becoming less fashionable because of the lack of flexibility in comparison to the Section 529 savings plans. I am going to restrict my discussion to the savings plans.

Georgia started its QSTP program in 2002. Its Web address is The site allows for online enrollment and features such tools as a financial calculator to show how much can be gained by starting a savings plan account early in the child's life. There is a state income tax deduction of up to $2,000 of contributions and a taxpayer does not have to file an itemized return to be able to claim the deduction, which makes it appealing to all taxpayers.

Aside from gift tax considerations, there is no annual contribution limit - only a cumulative contribution limit. When the total account balance of all accounts for the same beneficiary equals $235,000 no further contributions can be made. However, the account(s) reaching that "cap" can continue to grow due to investment performance.

The beneficiary of a 529 account can use the funds for a qualified educational expense at a public or private institution anywhere in the U.S. The definition of "educational expense" is surprisingly broad and includes remedial, technical and post-graduate education.

Withdrawals that are not used for a qualified educational expense are treated as taxable income and incur a 10% penalty. There are exceptions related to the death, disability of the beneficiary, or lack of need because of a scholarship.

The best feature of 529 plans is that a contribution to a plan qualifies as a "present gift" for purposes of estate and gift taxes and is therefore eligible for the $12,000 annual gift tax exclusion (as of January 1, 2008). Under current federal law, five years worth of contributions can be made in one year and, if the donor survives the subsequent four years, all of the money will be protected from estate and gift taxes. It is thus possible for someone to fund all of a child's college education with a gift made when that child is an infant.

The child does not have to be the owner of the plan at anytime (unlike custodial accounts that are turned over at age 21) and the account's owner (grandparent or parent) can change the account's beneficiary to someone else in the family for any reason (i.e. the original beneficiary does not pursue any education after high school).

The investment performance on 529 savings plans varies from state-to-state. Each state chooses a plan administrator, which is usually a major national investment firm. Georgia selected a subsidiary of TIAA-CREF that manages many plans throughout the country. One indicator of the company's investment management skills: the performance since inception (May 1, 2002) of the "balanced fund option" was 7.95% (annual return) as of November 30, 2007.

Another factor to consider is that the total investment management fees for the age-based investment options is capped at 0.78%, which compares favorably to the management costs in some other states. All of these figures are likely to change over time. Each person considering any investment should research the performance, competitiveness and management costs of Georgia's plan and any other plan under consideration.

A would-be donor should research the investment performance and the flexibility of a program (such as ability to change investment portfolios). There are many investment options within each plan with some being more conservative than others. Only in hindsight will an investment choice look brilliant or stupid. The federal rules allow a once-a-year shift from one state's plan to another, or a once-a-year change in the account's investment strategy. This is not a vehicle for trying to time the market or make a killing.

A good place for research of plans around the country is, which was founded by accountant Joseph F. Hurley. It has informative articles and ratings on all the 529 plans in the U.S. Some plans are better because of lower administrative costs or better investment performance, so research can really pay off. There is a rating system on the Web site that evaluates each state's program from the perspective of resident and non-resident taxpayers.

Whichever QSTP plan or other approach a person chooses, rising college tuition costs will not be a problem for those who plan ahead.