March 2002

New York State Section 529 Plans

By Marvin L. Korobow, CPA

To date, 48 states, including New York, have established college tuition savings plans under IRC section 529. Requirements and tax advantages vary from state to state. Because most states’ plans of this type are open to nonresidents, prospective account owners should investigate all states’ plans to find the one best suited to their needs and objectives.

The New York College Savings Program (NYCSP) is the name of New York’s section 529 plan. The plan permits an owner to—

• exert ownership and control over the account and the savings in it
• set up such an account with any relative (or even a nonrelative) as the beneficiary
• save for college on a tax-deferred and, since January 1, 2002, tax-free basis
• get an annual New York State income tax deduction
• set up such an account for themselves, if pursuing a college degree is in their future plans.

The account owner receives New York State tax benefits, but the beneficiary of the account has educational choices inside and outside of New York State. The beneficiary can apply funds from the account to schools outside of New York, whether public or private. Even graduate, vocational, medical, and law schools qualify. Some international and part-time studies qualify as well. The beneficiary can even be a resident of a state other than New York.

The income tax breaks are significant. Investments grow tax-free for as long as the money stays in the plan. Starting in 2002, qualified withdrawals are entirely exempt from federal income taxes; also, an account owner may roll over the account into the plan of another state as often as once each year, enabling the account owner to make a new investment choice (which is prohibited in New York State plans) if it makes sense.

In addition, New York State account owners may deduct contributions up to $5,000 per person each calendar year on their state income tax return. Married couples filing jointly may deduct up to $10,000 per year. Although the account owner is subject to New York State income taxes, she can benefit a child residing in another state and still get the New York State tax benefits.

The contribution to the plan qualifies in 2001 for the $10,000 annual gift tax exclusion. Additionally, an account owner who contributes $10,000 to $50,000 ($100,000 for married couples filing jointly) for a beneficiary can elect to treat the contribution as made over a five–calendar-year period. Thus the contributions and their income can get out of the owner’s estate faster than if the contributions were made each year while remaining sheltered.

Significantly, although the asset leaves the owner’s estate it does not leave the owner’s control—a remarkable benefit compared to the normal gift and estate tax laws. If an owner later revokes the account, however, its value comes back into the estate. An owner’s estate will include that portion of any contribution made under the five-year averaging election if the owner does not live to the fifth year (e.g., 80% of the contribution would revert to the estate if the owner were to die after one year).

Four types of investment options are available:

• The guaranteed option provides a return of at least a set percentage, although a greater return is possible based on investment performance.
• The managed allocation option consists of a blend of securities such as stocks, bonds, and money market funds. The mix is generally geared to the age of the beneficiary.
• The aggressive managed allocation option, while similar to the managed allocation option, generally has a greater exposure to equities.
• The high equity option generally has 75–100% invested in stock holdings.

A 10% penalty is imposed on nonqualified withdrawals (withdrawals not used by the beneficiary for higher education). The 10% penalty is imposed on earnings, not contributions. For example, if $30,000 contributed grows to $70,000, the 10% penalty would apply only to the $40,000 earned. This penalty does not apply if the beneficiary dies, becomes disabled, or receives a scholarship that makes the account unnecessary for its original purpose.

The total amount that can be contributed over the life of the account cannot exceed $100,000. Other states permit higher limits; for example, Rhode Island permits up to $265,000.

Accounts must be opened for three years before a qualified withdrawal can be made. So if the beneficiary is to attend college at age 18, the account should be opened before the beneficiary reaches age 15. Nevertheless, if the owner is financing an advanced degree or is waiting a long time to use the money toward the end of a child’s education, there is enough time to do this.

Although investment plans cannot be changed once chosen, additional funds can be subsequently invested into different investment options for the same beneficiary (e.g., funds can be invested in a more conservative fund when the child is older).

Creditors in bankruptcy proceedings cannot reach the assets in the plan, and creditors are also limited in their ability to satisfy judgments outside of bankruptcy proceedings.

Accounts in New York are not guaranteed by New York State. The funds in a New York plan are not limited to tuition, and can be used to pay mandatory fees, books, supplies, equipment, and room and board as well. In addition, New York State places no limits on the income, age, or duration of an account.

The account value is considered an asset of the account owner and therefore treated more favorably for financial aid purposes than if it were considered the student’s asset.

Parents whose children will be in college after 2010 must be aware that the section 529 plan legislation is part of the entire tax bill that is scheduled to sunset in 2011 unless lawmakers act before then.

A caveat for grandparents who expect Medicaid to pay their nursing home costs: The law is not fully settled regarding whether section 529 accounts are treated as an asset for purposes of determining Medicaid eligibility.

An account owner would be wise to designate a contingent owner to be in control if she dies or becomes incompetent. If no such contingent owner is designated, the executor of the owner’s estate should have the power to designate a new owner.

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