Everything You Need To Know About Qualified Tuition Programs (QTPs)

Many ways of saving for a college exist and one thing is certain: it is just the right time to start it. One of the newly devised plan to help you save is the qualified tuition program (QTP) or “section 529 plan.” This plan not only gives you a better way to save but also comes with tax advantages.

What are they about?

QTP lets you create a tax-advantaged account for your kids’ college fees. Two types exist under Section 529 plans:

• Prepaid tuition plans. This plan lets you cater for tuition expenses by purchasing credits which your kids’ will redeem when they get to college. The law limited the use of these plans to just state-run before but the 2011 Tax Relief Act allowed education institutions to create and run these prepaid plans starting January 2002.

• College Saving Plans. This plan allows you contribute to state-sponsored savings account thereby raising funds to cater for your children’s college education. Such accounts are normally being managed by the private mutual fund companies.

This is how it works: 

• Make a gift to create an account. You begin with creating a qualified tuition plan account and stating your child’s name as the beneficiary then start contributing. Your contributions are referred to as a gift. There is a tax-free exclusion of $11,000 for singles and $22,000 for couples contributing jointly.

• Contributions you make are limited. You are only allowed to make a contribution up to the amount required for your child’s tuition fee and that should not be exceeded. Each plan has its own set limit and this will depend on the duration that a given degree program takes. You can make a lump sum contribution or monthly contribution depending on the policy of the chosen prepaid plan.

• You are in control. You are the one in control of all the withdrawals that your child makes. You can permit withdrawal for fee expenses only. You can also change the beneficiary of the funds and still remain eligible for tax benefits. You can also request a refund if you later changed your mind but the tax and penalties will apply. Other educational accounts do not give such controls.

• You child can withdraw funds to cater for college expenses. According to Section 529, the funds must only be used for expenses related to higher education such as fees, tuition, books, supplies, and board expenses provided that the child attends school at least half the academic days. If a child gets a scholarship, you can place your request for a tax-free refund of the amount equal to the scholarship. You can withdraw the funds in event that the child dies or becomes disabled. If withdrawal is made for any other purpose other than the defined ones then you will have to pay tax on any amount that accumulated on the funds.

• Flexible plans. Initially, the law permitted tax-free rollover from one beneficiary to another within the same family without any penalty incurred. Currently, you can also rollover from one prepaid plan to another tax—free.

What are the advantages?

Section 529 plans give tax benefits – The contributions you make are tax-free which makes it grow faster than the same investment deposited in a taxable account.

Section 529 plan vs education saving options – You can’t make continuous payments to education savings account once your gross income has been adjusted to a given limit. However, everyone can make a contribution to 529 plan regardless of the amount of income. Other accounts such as custodial accounts generate taxable income which necessitates filing tax returns while Section 529 plans generate tax-free income if funds are used for the intended purpose.

Section 529 gives an estate planning opportunity – Section 529 plans allow parents or grandparents to move their money from an estate directly into the account which avails the funds to a child who can use them to pay for all college expenses.
 
What are the drawbacks?

This plan also has some advantages which are the following:

Hefty penalties if withdrawals are diverted to other uses – You can change your plans and decides that you are not taking your child to the college or an emergency arises and you need money for yourself. What happens when your child completes college with funds still in the account? You will be compelled to withdraw according to terms and conditions of your plan and you will be required to pay taxes on that amount as well.

Keep an eye on the GST trap – While changing the beneficiary to one of the family members who is a generation below the current beneficiary, then you will be expected to pay the generation-skipping tax (GST).

Your state plan may not meet the level of satisfaction you expected – Under this scenario, you can only rollover to another plan if your current plan allows it. However, if you simply choose to withdraw your money then penalties and income tax will apply.

Conducting Your Own Research

Federal income tax rules apply across all qualified tuition plans. However, it is important to note that each plan has its own unique feature. You can visit www.collegesavings.org for more details on this. If you have different plans, then you can base your evaluation on the following:

•    State income taxes.
•    Investment return.
•    Enrollment fees.
•    Contribution limits.
•    Check if contribution amount is flexible.
•    Penalties and fees charged for withdrawals.
•    Rollover to another beneficiary or prepaid plan.
•    Choice of schools.
•    Participation by nonresidents.
•    Beneficiary age limits.
•    Education expenses covered if they also include boarding expense.

Remember that tuition plans offer an attractive way to save money for college fee. Additionally, they are tax-favored. However, they are not fit for everyone and you can seek more advice from our experts. Just give us a call!