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Estate Planning & Trusts - 529 Plans

Educational Savings Plans Explained

Changes make Educational Savings Accounts more attractive.

EGTRRA (Economic Growth and Tax Relief Reconciliation Act of 2001) has modified the rules governing ESAs for taxable years beginning after December 31, 2001 and before January 2011, making the ESAs much more attractive vehicles for saving for educational expenses than before. Currently, the full contribution amount is $2,000 per year per student, an increase from the prior $500 contribution limit. Additionally, the AGI limitations have increased: married couples can make a full contribution so long as their combined AGI for the taxable year is $190,000 or less. You cannot make any contribution if your AGI is $220,000 or more though you can make a partial contribution so long as your AGI is between $190,000 and $220,000.

The advantages of the ESA are significant for students. While contributions to the ESA are not tax deductible for the contributor, they are at the least, tax deferred for students. Even better, if the funds in the ESA are expended for “qualified elementary and secondary education expenses” or “qualified higher education expenses”, distributions from ESAs are tax free to the student.

The definition of “qualified elementary and secondary education expenses” includes tuition, fees, academic tutoring, books and supplies related to the student’s enrollment or attendance at a public, private or religious elementary or secondary school; room and board, uniforms and transportation required or provided by the school; and the purchase of computers, computer equipment or Internet access to be used by the student and his or her family during any years the student is in school.

Private or religious elementary education expenses are now included (previously, only higher education expenses were included). This means that after-tax contributions to ESAs may grow on a tax-deferred basis and there is no income tax payable when the money is paid to the school on behalf of the student. Depending on a number of factors, such as rate of return and cost of the qualified expenses, this could result in significant tax savings. With respect to college, a student attending an eligible higher educational institution, at least half-time, may consider his or her housing which owned or operated by the school as a qualified higher education expense, in addition to expenses such as tuition, books and supplies. And, if a student utilizes the ESA while in college, it does not disqualify him or her for the Hope Scholarship Credit or the Lifetime Learning Credit.

So long as the ESA is distributed for those qualified expenses and the entire account is either completely distributed or rolled over to another child, the distributions are not taxed and there is no penalty. Any withdrawal that is not used for qualified education expenses is taxed and is subject to an additional 10% penalty.

And, just as with an IRA, you can fund the ESA until the tax deadline each year. In other words, your 2002 contribution can be made up until April 15, 2003.

Back to School (Tax) Savings! Take advantage of these tax breaks for students!

Coverdell Education Savings Accounts (ESAs), formerly known as Education IRAs, allow students to accrue tax-free earnings for qualifying educational expenses. At the same time that these accounts allow parents and grandparents to help students save for college, they can provide significant estate and gift tax benefits, as well.

Qualified Tuition Programs (QTPs) allow for the prepayment of a student’s tuition or contribution to a higher education savings account. Payments or contributions to a QTP are not deductible for federal tax purposes though distributions from state programs are tax-free to the extent they are used for certain qualifying higher education expenses. The same tax-free treatment will apply to the prepaid tuition programs of educational institutions in 2004.

Taxpayers with incomes up to $65,000 ($130,000 on a joint return) may receive tax deductions of up to $3,000 of qualified higher education expenses for courses for the taxable year 2002. Even better, taxpayers do not have to itemize deductions on Schedule A to claim this benefit. However, a taxpayer may not claim both this deduction and a tax credit for education expenses for the same student in one year and if expenses are paid by a tax-free distribution from a Coverdell ESA, a QTP, or an education savings bond, the deduction may not be claimed.

Employers may provide their workers with up to $5,250 a year in tax-free educational benefits. This provision, which would have expired at the end of 2001, is now a permanent tax benefit. It has also been extended to apply to graduate studies, for courses beginning after 2001.

Deductions for interest on student loans for higher education may be taken whenever paid and regardless of the age of the loan. Prior to 2002, only payments made within the first five years of the repayment term counted and voluntary payments did not qualify for the deduction. This deduction is now available to taxpayers with incomes up to $65,000, with the deduction amount phasing out as income increases above $50,000. For married couples filing jointly, these figures are doubled.

Although scholarships are usually taxable if they carry a future service requirement, tuition, books and other equipment paid for by National Health Service Corps or Armed Forces Scholarship Programs will not be taxed. This benefit does not extend to room and board payments under these programs.

See our newsletter article (Volume 2, Issue 1, dated March 31, 2001) for more information on 529 plans and QTPs.

Links

• PA Tuition Assistance Program

• Savingforcollege – Internet guide to section 529 plans