March 2002

Section 529 Plans Tax-Free as of 2002

By Alan D. Kahn, CLU, ChFC, CPA, The AJK Financial Group

The Economic Growth and Tax Relief Reconciliation Act of 2001 greatly expands the potential benefits of state-sponsored IRC section 529 college savings plans. Beginning in 2002, qualified withdrawals from section 529 plans are tax-free for all federal purposes. Account balances have the potential to grow faster than comparable taxable accounts such as Uniform Gift to Minors Act (UGMA) and Uniform Transfers to Minors Act (UTMA) accounts because taxes do not eat away at account earnings each year.

Expanded flexibility. Under the new regulations, assets in one state’s 529 plan may be rolled into another section 529 plan tax-free as often as once every 12 months without changing the beneficiary, provided the money is reinvested within 60 days.

Beginning in 2002, contributions may be made to both a section 529 plan account and an Education IRA for the same beneficiary in the same year.

The definition of qualified higher education expenses has been expanded and now generally includes the cost of room and board, as determined by each educational institution for federal financial aid purposes. This replaces the previous rule which limited qualified room-and-board expenses to $2,500 (off-campus living) and $1,500 (at-home living). The definition of qualified expenses has also been expanded to include any expenses of a special-needs beneficiary that are necessary in connection with her enrollment or attendance in college.

For the purposes of rollovers and changing beneficiaries, first cousins of the original beneficiary are now considered to be family members.

Estate planning. In 2002, contributions can be as high as $55,000 per beneficiary in the first year of a five-year period ($110,000 for married couples filing jointly) without exceeding the annual gift tax exclusion, provided no other gifts are made to that beneficiary during the same five-year period. These high contribution limits provide a convenient way to effectively lower the taxable value of an estate.

There are no income limitations with respect to contributions to section 529 programs. Additionally, the donor always retains control over the account, even when the child reaches majority, a key advantage over a UGMA account. Under the UGMA, when the child reaches majority, she is free to spend the money however she chooses. With a section 529 plan, however, the donor always retains control over the account.

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