As discussed in our 2001 year end Tax UPDATE, a Qualified Tuition Program, which is commonly referred to as a Section 529 Plan, provides a tax efficient way to fund a beneficiary's higher education. A Section 529 Plan is a plan that allows you to either purchase tuition credits or certificates on behalf of a beneficiary, or make contributions to an account to pay for future "qualified higher education expenses" of the beneficiary (this latter and more popular form of a Section 529 Plan is referred to commonly as a "529 Savings Plan"). Qualified higher education expenses include tuition, books, supplies, necessary equipment, and reasonable room and board.
Contributions to a Section 529 Plan qualify for the gift tax annual exclusion (currently $11,000 per recipient, or $22,000 if the donor is married). A person can even contribute more than $22,000 tax-free in a given year to a Section 529 Plan by electing to accelerate the use of as much as five years' of gift-giving exclusion (this would allow a maximum contribution of $110,000 in a single year for a married couple, per beneficiary). The assets in a Section 529 Plan grow income-tax free and these assets are not taxed when they are distributed provided that they are used for "qualified higher education expenses."
A new tuition credit Section 529 Plan is now available called the "Independent 529 Plan," which includes over 200 participating private colleges and universities, such as Amherst, Boston University, Carnegie Mellon, the University of Chicago, Emory, and Princeton, just to name a few. The Independent 529 Plan, in effect, allows you to pay for the beneficiary's future college education at today's tuition rates.
How the Independent 529 Plan Works
You purchase a tuition certificate for a designated beneficiary. The value of the certificate at a participating college/university depends on the dollar amount you pay for the certificate, the cost of tuition at the college/university at the time you purchase the certificate, and the certificate discount rate being offered by the college/university. The certificate would later be used by the beneficiary to pay for tuition at any participating college/university. Here is an example of how this would work:
You purchase a certificate for $15,000 for your daughter, Ashley. At the time of purchase, annual tuition at Participating College A is $15,000 and annual tuition at Participating College B is $30,000. Further, at the time of purchase each Participating College offers a discount rate on tuition. When Ashley is ready to attend college, annual tuition at Participating College A is $25,000 and annual tuition at Participating College B is $40,000. Ashley is accepted at both Participating Colleges.
If Ashley attends Participating College A, she will be credited with 1 year of tuition plus an additional amount of tuition depending on the discount rate at the time of purchase of the certificate. If Ashley attends Participating College B, she will be credited with one-half year's ($15,000/$30,000) tuition plus an additional amount of tuition depending on the discount rate at the time of purchase of the certificate. As previously stated, the growth in the value of the certificate is not taxed.
Advantages
The Independent 529 Plan allows you to pay for the tuition at today's tuition rates. Further, at the time of purchase of the certificate each participating college/ university must offer a discount rate (which must be a minimum of 0.5%) on its then cost of tuition. The value of the discount compounds every year from the year of purchase until the certificate is redeemed.
Another advantage of the Independent 529 Plan is that, if the beneficiary does not pursue an undergraduate education at a participating college/university, you are entitled to a refund, adjusted for investment performance (capped at a maximum return/loss of 2% per annum). The dollars invested (adjusted for investment performance) can also be rolled over into a regular Section 529 Plan without income tax consequences.
Even if a participating college/university withdraws from the Independent 529 Plan, it must honor any certificate purchased before its withdrawal. Further, if the Independent 529 Plan is terminated, the colleges/universities must honor any certificate for at least 20 years. This is in contrast to most state-sponsored prepaid tuition plans, such as those sponsored by Florida and Illinois where, if the plan is discontinued, certificates will be honored only if the beneficiary is currently attending or within 5 years of attending the state's public colleges/universities.
Disadvantages
One of the disadvantages of the Independent 529 Plan is that it may only be used to pay for tuition and mandatory fees at participating undergraduate institutions. Compare this to a 529 Savings Plan where the account assets may be used to pay for tuition at graduate and vocational schools, as well as reasonable room and board expenses at any accredited undergraduate, graduate, and/or vocational schools.
Another potential disadvantage is that the money you used to purchase a certificate may have grown at a higher rate if it had instead been invested in a Savings Plan. Remember that any refund of assets invested in an Independent 529 Plan is adjusted for investment performance with a cap rate of 2% per annum.
Summary
The Independent 529 Plan offers you an opportunity to freeze the cost of tuition at a participating college/university while also allowing you to enjoy the benefits of a Section 529 Plan. You may also find additional information of interest at www.independent529plan.org.
