There are two types of qualified tuition or 529 programs: prepaid plans, and savings plans. As with a Roth IRA, you don’t get a federal income tax deduction for either type of contribution; similarly, the earnings on the assets in the account aren’t taxed while the funds are in the program and distributions from the program are tax-free up to the amount of the student’s “qualified higher education expenses”.
Here are a few details:
- Prepaid Programs: Some colleges 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. This effectively locks in today’s rates for tomorrow’s enrollment. For example, if a child is accepted to college starting 2020, you could buy four years worth of tuition credit from their college in 2019 at 2019 rates.
- Savings Programs: Tuition amounts covered are dependent on the investment performance of the fund(s) you place your contributions in.
- Qualified higher education expenses: Tuition (including up to $10,000 intuition for an elementary or secondary public, private, or religious school), fees, books, supplies, and required equipment, together with reasonable room and board is also a qualified expense if the student is enrolled at least half-time, are considered qualified higher educational expenses. 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 is also imposed.
- Beneficiary: The beneficiary of the program is specified when you start the funding. You can, however, change the beneficiary or roll over the funds in the program to another plan for the same or a different beneficiary without income tax consequences.
- Eligible schools: Any college, university, vocational school, or other post-secondary school eligible to participate in a student aid program of the
Department of Education are eligible schools for these programs. This includes nearly all accredited public, nonprofit, and proprietary (for-profit) post-secondary institutions. The contributions you make to the qualified tuition program are treated as gifts to the student. These contributions qualify for the annual gift tax exclusion amount ($15,000 per person per year for 2019) adjusted annually for inflation. If your contributions in a year exceed the exclusion amount, you can elect to take the contributions into account over a five-year period starting with the year of the contributions. For example, you could contribute up to $75,000 ($15,000 x 5) per beneficiary in 2019 without gift tax. If you and your spouse both contribute, you could give up to $150,000 for 2019 per beneficiary, subject to any contribution limits imposed by the plan.
In setting up the 529 programs, keep in mind that you may not be able to make the distributions from the program when a very young (or unborn) beneficiary goes to college, so you should designate who can make such distributions as the alternative custodian.