ACC610DiscussionsWeek 5 - Discussion 1- Qualified Tuition Programs

Week 5 - Discussion 1

A qualified tuition program (QTP) is “a program established and maintained by a state, or an agency or instrumentality of a state, that allows a contributor either to prepay a beneficiary’s qualified higher education expenses at an eligible educational institution or to contribute to an account for paying those expenses” (IRS, 2019, Topic Number 313).

Two distinct strategies exist. The first involves putting money away, while the second involves paying for college ahead of time. The minimum allowable contribution varies by state and the plant selected for the beneficiary. Both the initial deposit and the yearly minimum contribution amount may be mandated by the plan and the state where you live.

To keep the account value manageable, college savings plans restrict the account. If the total balance of the account (contributions plus investment gains) reaches the state cap, no further deposits will be accepted. If the state allows a maximum deposit of $200,000, for instance, no more deposits can be made after that amount is reached.

However, if multiple people contribute to a beneficiary’s account, that cap drops to $200,000. For example, if Sue’s grandmother desired to contribute to her 529 plan, they could each give up to$200,000. Even though contributions to a 529 plan are not deductible on a federal level, they may be eligible for a partial or full credit against state income taxes in several jurisdictions.

The gains are not subject to taxation if the 529 plan’s earnings are utilized for qualified higher education expenses. But if you take money out of your 401(k) without meeting the requirements, you’ll incur income tax on the earnings and a 10% penalty. Any amount given by an individual to a beneficiary under the age of 30 is free of gift tax.

However, the cap has been set at $14,000, and any additional donation contributions cannot exceed that amount. By spreading the donation out over five years, you can avoid paying federal gift tax on gifts up to $70,000 (or $140,000 if donated jointly) from a 529 plan. This way, parents can contribute to their child’s 529 plan together as a gift. However, they would be unable to make additional gift contributions to the same beneficiary without incurring gift taxes.

While the assets in a 529 plan are always accessible to the donor, they are excluded from the donor’s taxable estate for estate tax reasons. However, income tax and the 10% additional penalty on gains must be paid on the asset. Income tax benefits are only gained if the money is used for higher education, and a beneficiary must be named. Therefore, 529 plans can be used as a strategy in estate planning to remove assets from an individual’s estate while still allowing them to have some control over the funds.

Example scenario:

Michael and Lisen wish to spend $14,000 annually on their daughter Alexis’s schooling. In this case, their annual contribution halves to 28,000 per person. In other words, parents cannot deduct this amount from their taxable income. They will each make equal contributions over the next five years. As a result, they have put away $140,000 for Alexis’s college tuition. There would be no Federal Income tax benefit to the parents. The parents are exempt from the Federal Gift tax but cannot make any additional donations without incurring additional tax liability. The parents have neatly transferred $140,000 to their child free of Estate tax without lowering their tax exemption limits.

ANY

withdrawals of 140,000 plus gains are not subject to tax if used for education as per the 529 plan.

References:

Internal Revenue Service (IRS). (2019). Qualified tuition programs (QTPs). Retrieved from:

https://www.irs.gov/taxtopics/tc313cuLinks to an external site.