Section 529 plans—named after the qualified tuition programs section of the United States Internal Revenue Code—are founded and maintained by individual states as an incentive for families to save money towards their children’s higher education costs. By using either a prepaid tuition plan or college savings plans—which vary in terms of flexibility and the ability to guarantee a future tuition rate at certain schools—a family enjoys the benefits of early financial planning for college without having to pay taxes on accumulated earnings or eventual distribution of funds –provided that specific requirements are met. Plus, in certain circumstances a state tax deduction for contributions may be available. Additionally, a family can take advantage of the rules governing the gift tax exclusion to more quickly build up the assets in their 529 plan.
In 2014, the annual gift tax exclusion is $14,000. However, tax law will allow you to contribute up to five times that amount at once to a section 529 plan—a total of $70,000—without requiring your family to pay any gift taxes. The IRS treats this gift as if it were spread out over a period of five years. (Note that any further contributions may be covered by the lifetime gift tax exemption of $5.34 million, although this will affect your estate tax shelter down the line.)
A section 529 plan is named for a single beneficiary, but anyone is allowed to contribute to it—so let grandparents, or anybody else with an interest in the child’s college plans know how they can help out! There will be a state-mandated ceiling to each plan, however, so be aware of them when you budget how much you intend to add to it. Also, remember that the tax exemptions in a Section 529 are built specifically around savings being applied to tuition costs for education. Using this money for other purposes will trigger taxes and penalties at both the state and federal levels.