The Scoop about 529 Penalty on Refunds

One of the downfalls to the 529 plan is it is intended solely for college. Unlike other types of investment tools, such as CDs or stocks, where the money applies for whatever purpose you deem best, a 529-college tuition savings plan is solely for college fund use.

This is why they offer the option of multiple beneficiaries as well as the opportunity to switch beneficiaries to relatives such as grandchildren or other relatives should the original beneficiary have no use for the money. It is possible, however, to gain access to the funds without college as a purpose, but there are penalties involved.

It is important that you understand the scoop on 529 penalties for refunds. A refund on a 529 fund is a non-qualified withdrawal; meaning that the money is for any purposes other than for use at a qualified school.

If you do need to get a refund on the money you have invested throughout the years, the first fee involved will be state and federal income tax on the earnings of the money. Of course, the longer you have been investing, the more money you will have contributed, hence higher earnings.

This is particularly true if you have been investing since your child was young and the higher risk investment methods had a higher payout. This money could add up to quite a bit, so it is important to understand that you are accountable for these funds.

This applies to both the state level of earnings taxes as well as the federal level. This money is now income, potentially pushing your earnings into a higher tax bracket and costing even more, so this is a very important detail to consider before withdrawing funds for non-qualified purposes.

In addition to this, there may be a 10% penalty enforced at the federal level due to the money not used for college. It is important to contact a representative from the program you are either using or will be using to ask about this penalty so you can fully understand the risks. This high of a percentage can add up to a lot, particularly if you invested for many years.

It is best to understand all the options fully so that you know what you are getting into before even beginning the program, particularly since the 529-college tuition savings plan is one that requires a commitment every month. If you know that there is a high risk of the need for early investment, or if you know your child may not attend college, you may want to consider other investment tools.

While other types of investment tools may not be able to offer as many benefits as the 529 savings plan, they may offer fewer penalties for non-qualified use of the money. By studying all the different investment tools, and weighing in your particular needs, you will be able to determine whether this type of fund is the best way to go.

Once you have went over everything, you can then decide whether the risks involved are worth the benefits to you, or whether you would prefer a safer avenue of saving for your child’s college tuition. Since you invest so much time and money in this type of life-changing event, it is always best to pick the one that will work best for you and your family.

This also means fully considering how likely it is that you will need a refund on the account or that you will need to make early withdrawals. Knowing this will help you decide which type of account is right for you and whether or not the penalties for refunds on a 529 plan should be of any concern to you.

529 Plan’s Future when College is not in the Future

What would happen to your daughter’s 529 plans future when college is not in the future? This is an excellent question to consider. As you look at your three-year-old daughter, all you can see is how smart, beautiful and intelligent she is.

Of course she’s going to a very good and probably very expensive college! At least, this is what you and your spouse determined even before she was born when you opened up her 529 plan. But what if (gasp) college just isn’t right for her? After all, it’s not the right place for everyone.

Well, you do have a few options. You can do nothing. You can hope and pray that she changes her mind and decides to go to college at another point in her life. Or in reality, beg and plead and badger her into going to college. If you make this choice and your stubborn little angel still has not used the 529 monies, she can be the contingent owner of the account.

Then, when you die, she will become the owner and can change the beneficiary from herself to one of her children. This 529 plan then becomes a gift from you to your grandchildren without passing through our estate.

More realistically, you would change the beneficiary from your daughter to her younger brother. Being a sibling, he would have an approved relationship to the previous beneficiary (our daughter).

Approved relationships to beneficiaries are as follows: son, daughter, grandchild, stepchild, father, mother, stepparent, brother, sister, stepbrother, stepsister, nephew, niece, uncle, aunt and the spouse of any of the before mentioned individuals. Two other options for transfers would be your daughter’s spouse or a first cousin. Needless to say, there are a lot of choices of people to transfer this 529 plan to.

You could also take the money out of her account and use it for yourselves. Vacation money, perhaps? But there will be a 10% penalty on the earnings portion of this nonqualified distribution. The penalty is not assessed on principal. The earnings on this 529 plan will be taxable at the usual income rates. The good news is that the money that you originally invested can be withdrawn without tax or penalty.

Now just a brief glimpse of the unthinkable, what would be the future of my daughter’s plan if she were to die? The rules for this are a little murky. It appears that the funds would have the 10% penalty waived if you would have the funds distributed to your daughter’s estate.

Or, once again you could change the beneficiary to your son, which would not incur a tax result. These rules would also apply if your daughter would become disabled or if you would withdraw the funds because the funds are not needed for college because our daughter has received a scholarship.

If college doesn’t become the plan for you daughter, the best option for you would be to change the beneficiary to your son. You place a great deal of importance of a college education and believe that 529 plans are the best place for you to invest for our children’s future.

For any family, the benefits of investing in a 529 plan far outweigh the risks involved. It’s just nice to know that if your children decide not to pursue a college degree that you have options to consider. This is a summary of the 529 plan’s future when college is not in the future. It’s just hard to predict what will happen in your crazy so-called life.

The Ins and Outs of Controlling a Coverdell ESA

Be sure of exactly who controls a Coverdell ESA; know all of the ins and outs. No one wants to deal with the headache of an 18 year old discovering their education fund only to run rampant making unqualified purchases. Of course, this would not be the behavior of every college student, but it will happen to someone out there somewhere. Here are some control ins and outs for your consideration.

With a 529 plan, you can keep in complete control of the account as the account owner and can even have the value of the account refunded for your use. This is a little different with a Coverdell ESA. The responsible person (parent or guardian) must administer the account for the benefit of the child.

Any money that you take out of the ESA must be for the benefit of the child. It should not be refunded to the person who established the account. Coverdell accounts are essentially an irrevocable gift.

Since the beneficiary of the Coverdell is not of age when you start contributing to the account, when the account is started an adult is named the responsible individual. This individual is typically the parent or guardian of the child. There will be policies at the financial institution you select to handle your ESA that determine the supervisory authority for the account.

The responsible individual may be able to retain that authority for the life of the account. If they wish this individual may be permitted to transfer the authority to the child at age 18.

With a Coverdell ESA, the responsible individual has more control to prevent the child from using funds for non-qualified purposes than UTMA or UGMA accounts. (Uniform Transfers to Minors Act and Uniform Gifts to Minors Act) If the account is not completely empty by the time the beneficiary reaches age 30, the balance will be paid to the beneficiary in 30 days.

In case of the death of the beneficiary, the account will be paid to their estate. This is unless there is an authorization from a legal representative to change the beneficiary to a surviving family member or spouse who is under the age of 30.

As the responsible party you have the control to change the beneficiary to another family member at any time as long as there was an agreement when the account was started. Then, you can change the beneficiary to another family member under 30 without having income tax and penalty. This includes anyone in your immediate family, including stepchildren or stepsiblings and cousins.

If you are the grandparent who has established this account you will not be able to change the beneficiary or have the account refunded for your use. Your choices are to name the parent, guardian or child as the responsible individual, you will more than likely not be able to name yourself.

You should look to restrict the powers of the responsible individual if you do not want the parent or guardian to be able to change the beneficiary. It is understandable if you want the account to stay in the name of your named beneficiary no matter what the circumstance. In this instance, you do not have the same control of the ESA that a 529 plan would grant you. This may affect your decision on which account you select.

If you have more questions on your Coverdell ESA, talk with the providers of the account. This is a great way for parents, grandparents and children to work together to pay for future education expenses. The ins and outs of controlling a Coverdell ESA are important. It’s good to know exactly who’s in control of your money.

What Contributing Grandparents need to know about 529’s

What exactly should grandparents need to know about 529 college plans? Some things just seem to go together like hot dogs and baseball, peanut butter and jelly, and of course, grandparents and 529 plans.

It’s a very lucky family that can depend upon grandma and grandpa to help with college tuition bills. College expenses aren’t exactly shrinking. The best gift that anyone could give could be your grandchild’s education fund and a 529 plan is a great way to get started.

A 529 plan is a state sponsored savings plan that invests money on behalf of beneficiaries. The earnings are tax deferred from federal income tax and most states have programs that will defer state taxes. If your grandchild uses the money from this fund for any qualified education purpose, the withdrawals will be free of tax.

Grandparents are allowed to contribute up to $11,000 per year per grandchild. So if Grandpa and Grandma have two grandchildren could place up to $44,000 in funds for the grandchildren without any gift tax liability. The grandparents would each have to set up 2 funds for each grandchild (a total of 4).

Grandparents will still have control over these funds and can retrieve the money if needed. Of course, there will be taxes and penalties on an unqualified withdrawal but the taxes and penalties will only be on your earnings, not on the amount of the original contribution.

The 529 plans have lots of investment options, which create a big decision for the grandparents to make. Grandparents typically are more conservative than the child’s parents. The most popular approach to 529 investments tends to be the age-based option. This is a simple way to save for college. You do not have to personally adjust your allocations over time.

The fund is managed according to the age of your grandchild. Younger children have more of a stock concentration. As your child gets older, the assets are automatically shifted into a higher ratio of short-term investments and more stable bonds.

Grandparents could also check and see if the 529 plan that your have set up will accept a third party contributions. This will take all of the worry about opening and maintaining your own accounts. State tax deductibility may be an issue if you go this route. Some states allow you a deduction for at least part of your contribution to their 529 plans. As a third party donor you will not be eligible for this deduction.

If you ever need to apply for Medicaid benefits, the state will look at your 529 plans as countable assets. You are eligible to take back the money you’ve invested so the money is technically available to pay medical or nursing home expenses. If you have this concern, it is an issue to discuss with your tax professional or attorney. It might be a good idea to make someone else the owner of the fund.

A big concern for grandparents is what would happen to the money in the 529 accounts if your grandchild chooses not to attend college. A great option is to change the beneficiary to another family member or even yourself. You can change the beneficiary as much as you want.

Another option is to take the money in the fund for your needs. The earnings in the account will be subject to a 10% penalty rate and will be taxable as income.  This is some of what contributing grandparents need to know about 529’s. It is a great way to invest in your grandchild’s future. You have picked an incredible gift to give to your very lucky grandchild.

Roth IRAs – A Viable Option for College Funding?

Lately, there has been much confusion regarding the benefits of using a Roth IRA to finance a college education on a tax-free basis. This is due to the complexity of rules on taking distributions/withdrawals from Roth IRAs. There are two kinds of money in a Roth IRA: contributions and earnings. Unlike a traditional IRA, contributions to a Roth are never tax-deductible.

Since taxes have already been paid taxes on the contributions, these can be withdrawn at any time, for any reason, without paying taxes, although they may be subject to the early 10% withdrawal penalty if they come out of a Roth within five tax years. Fortunately, that penalty is waived if the contributions are used for higher education expenses such as going to college.

The same can be done with non-deductible contributions made to traditional IRAs. But, the money earned by those contributions, such as capital gains, interest and dividends is untaxed money. Untaxed money cannot be taken out without paying income tax on it until the age of 59 1/2 or older. There are some exceptions to this rule, but unfortunately higher education is not one of them.

If the earnings are withdrawn from a Roth, they are taxed at ordinary earned income rates, not the more favorable capital gains rates. Don't even think about using Roth earnings for college. A person would be far better off with a taxable account. However, a person can use Roth contributions for college.

This option is viable only if the individual has some other type of retirement plan that is funded to satisfactorily.  Obviously, the individual’s future support should come first, and the individual’s children can work their way through college. Thus, as long as the Roth isn't all that stands between a person and a mediocre, poverty ridden retirement, then yes, the Roth has some potential for college funding.

Nobody will lend an individual money for a comfortable retirement, but a student can borrow money for college. The point of saving for college is to hopefully avoid the need for a student to borrow.

But bumps in the financial road do happen sometimes, and the bottom line is that if it comes down to an either/or situation, it's more important that there is a reasonable level of retirement savings more than large college savings fund.

As far as the tax advantages are concerned, a person might as well hide the money under a mattress. The individual is simply putting some money, on which taxes have already been paid, into the Roth for a while, then taking it back out and using it to pay for college.

No taxes are paid on that kind of withdrawal just like a person wouldn't pay taxes on withdrawals from a savings account, or money you stashed in a coffee can. The tax advantages of saving for college in a Roth is good. While a person will not get tax-free treatment on earnings saved in a Roth if used for college, the contributions can be withdrawn for college expenses without tax or penalty.

The obvious solution is to leave the earnings in the Roth for retirement and withdraw the principal to pay college bills. There is some flexibility in using a Roth IRA, but here are also yearly contribution limits for the Roth, with the annual limit for the Roth IRA increasing to $4,000 in 2005, a married couple will be able to save a full $8,000 per year in Roth IRAs.

Many families with kids aren't going to be able to save more than that anyway, and if they can, the Coverdell accounts are still available to save an extra $2,000 per child per year. The treatment of college funding is often confusing, it is sufficient to say that having college savings money held in a Roth IRA can simplify the treatment of financial aid and education tax credits.

The Pros and Cons of the Coverdell ESA for College

As you’re setting up investment plans for your child’s college, it’s smart to be aware of the pros and cons of the Coverdell ESA for College. This educational savings account is a very attractive savings plan for many people. Let’s take a look at some of the negatives and positives of this program and so you can see if it’s a fit for you.

Pro- The Coverdell Education Savings Account can be self-directed with a wider array of investment products available than a 529 plan. The account can be placed in almost any sort of investment. Typically, stocks, bonds, bank CDs, mutual funds and unit investment trusts. No part of trust assets may be invested in life insurance contracts.

Pro- The Coverdell funds are available to finance elementary and secondary school, not just college. This includes items such as tuition, fees, tutoring, books, supplies, room and board, uniforms, transportation and computers.

Pro- Earnings accumulate tax-free. Qualified distributions are exempt from federal income tax. Please note that contributions are not deductible on federal or state income tax.

Pro- Corporations may contribute. This even includes tax-exempt organizations. Regardless of income level, corporations may contribute to an individuals Coverdell account.

Pro- People can contribute to both a Coverdell account and a section 529 plan in the same year. Note that there may a gift tax implication if you give more that $12,000 per beneficiary.

Con- Contributions to the Coverdell ESA are limited to $2000 per beneficiary per year. Here’s an example, you have a son and a daughter that you want to contribute $3500 into Coverdell accounts for. You deposit $2000 to your son’s account and $1500 into your daughter’s.

Their grandmother wishes to add another $1000 but she is only allowed to put $500 into your daughters account as the $2000 limit has been reached. At $2000 a year, it would be tough to have this be your entire college savings plan.

Con- Contributions can only be made until the beneficiary reaches age 18. This may be a non-issue with some families but a 529 plan would allow you greater flexibility. There are no age restrictions for special needs beneficiaries.

Con- The money must be used by the time the child reaches the age of 30. If the funds are not used, the earnings will be taxed as ordinary income plus a 10% penalty.

Con- There is less flexibility in changing beneficiaries in a Coverdell ESA. Coverdell plans are considered permanent gifts. You cannot open up an account for your child and take back the money for your own use. Typically, the parents are responsible for the account until the child reaches 18. Then, the beneficiary usually takes control of the account. There is some ability to change beneficiaries.

Con- The Coverdell ESA is not eligible for the state tax deductions available for some 529 plans. The available 529 state tax deductions vary from state to state. Of course, a tax deduction is not the only reason to select an investment.

Con- The contribution limit is phased out for contributors with an adjusted gross income between $95,000 and $110,000 for single people and between $190,000 and $220, 000 for joint filers. A clever way around this con if you’re in this income bracket is to give the money to your child and let her open a Coverdell for herself.

After looking at the pros and cons of the Coverdell education savings fund, you can see if this is a wise investment for your child. The items that have been identified as cons are non-issues for many people. Coverdell is a good investment overall for most families. Talk with your tax profession and see if it’s right for you.

Learning about State Tax Deductions with 529 Plans

When planning ahead and investing in a college savings plan to make sure that money is available for a child’s college education it’s important to learn everything possible about the many different types of college savings plans and the different rules regarding taxation of those savings plans.

For parents, this information can be confusing but it’s very important to make sure that the investment is set up correctly and the best type of investment is chosen to make sure that the money the parents have to invest makes as much money as possible for the child’s education

Most parents end up investing in 529 college savings plans but the laws surrounding 529 college savings plans are complicated and can be different in each state since the 529 college savings programs are state run.

Learning about the state tax deductions allowed for 529 college savings plans is very important. The laws regarding taxes, tax deductions, and 529 college savings plan are different in every state, so parents should look for information regarding taxes and 529 college savings plans in the state where they live before investing.

Parents who invest in a 529 college savings plan that is not a pre-paid college savings plan are not eligible for a Federal tax deduction on the amount of that investment however investing in a 529 college savings plan does have some benefits because money invested in a 529 college savings plan is tax free, and deductions made from the 529 college savings account that are applied to educational costs are also tax free.

Some states offer parents a state income tax deduction on money that it is contributed to a 529 college savings account. Each state is different, but it’s easy to find information about 529 college savings plans and tax laws that are listed by state so that residents of each state can find out what the laws are where they live and what tax deductions, if any, they are entitled to when opening a non pre-paid 529 college savings account for their child.

In terms of taxes, the thing to watch out for when investing in a 529 college savings plan that is not a pre-paid 529 college savings plan is the penalties and tax fees for early withdrawal of that the investment money.

If parents withdraw the money from a non pre-paid 529 college savings plan account for any reason other than applying that money to specified higher education expenses there is a significant early withdrawal fee and tax penalty.

When the investment is withdrawn early and not used for educational purposes, the amount of money that withdrawn from the earnings portion of the 529 college savings account will become subject to state income tax plus an additional 10% tax on that portion of the investment.

There are a lot of rules and complicated issues when it comes to non pre-paid 529 college savings accounts and parents should make sure that they understand all the rules and the tax laws regarding 529 college savings accounts before they invest in a 529 college savings account to make sure that in the future they are not left in a situation where they didn’t put away enough money for their child’s education or end up paying heavy tax penalties and fees and end up without enough money to pay for their child’s education because they didn’t understand the tax laws regarding 529 college savings accounts when they first opened the account.

It’s more important than ever these days to put aside some money for a child’s education because college costs are skyrocketing every year. Be sure to invest wisely to make sure that the investment provides enough money for the child’s future college education.

Why Consider Out of State 529 Plans?

Why go out of state to shop for a 529 plan? Should you be considering other options? Let’s face it, not all state 529 plans are created equally. It is recommended that investors look at their home-state plans as a first option.

Some states have great incentives such as state tax deductions on contributions and matching grants. A poor 529 plan may wipe out the benefits such as deductions and grants. Look for a state tax deduction calculator on-line to determine the value of the benefits.

Make sure you find the plan with the lowest fees. Take a look at the Utah Educational Savings Plan Trust. With this plan you will find nine tried and true index and international offerings from Vanguard with a charge of only 0.38% per year for it’s most expensive option. You can compare this to Nebraska’s AIM College Savings Plan that has a heavier price of 1.35% to 1.61% with traditionally weaker funds.

Conservative investors should be aware of how much their state plans put into the stock market. The Michigan Education Savings Program is a good choice for the cautious investor. The plan even has a savings option, with no annual fee, that guarantees a minimum yearly interest rate and principal based on a Treasury note index. This plan also has portfolios of TIAA-CREF mutual funds that are more like bond funds than other 529 plans.

Look and see if your state 529 plan has the best portfolios of underlying funds. Compare it to plans like the Maryland College Investment Plan. They use a great blend of funds from T. Rowe Price. And the plan’s most expensive option costs just 0.98% annually.

Some people prefer to build their own portfolios. Look for a state that has a good mix of investment choices. For example, the College Savings Plan of Nebraska offers a selection of 20 funds including Vanguard, American Century and Fidelity funds.

In 2006, Kansas, Maine, and Pennsylvania all passed “tax parity” laws. This means that tax deductions are extended on contributions to residents who have invested in 529 plans from other states. This is unlike the other states that only extend state tax breaks to those who selected in-state plans. This tax parity law allows more flexibility to investors to select investments more suited to their wants and needs.

Look for a 5 Cap 529 program. States are rated on a scale of one to five. A 5 Cap program meets high standards in program flexibility, liquidity and availability of assets, strong ownership rights, state benefits, investment approach and safety, and program resources.

Three plans that have 5 Cap ratings and have been rated among the best 529 plans are the Maryland College Investment Plan, the Utah Educational Savings Plan and the Virginia College America Plan. Check them out to see how they compare to the plan in your home state.

All savings and prepaid plans are transferable to out-of state and private institutions. There will be no penalty if you have an out of state 529 plan if your child attends a local college. Your child will still be eligible for in-state tuition in the home state. They will still pay the lower tuition for Iowa students if you use the Nebraska plan.

It’s not advisable to flutter among 529 plans from state to state. Do your research or talk with a financial advisor. Pick the plan that makes the most sense for your family. Your state may very well have the plan that works best so why consider out of state 529 plans? Because it’s your money and you need to make sure it’s working hard for you!