Section 529 Plans for Pennsylvania Residents
This Article will discuss 529 Plans and will focus on
some of the estate planning advantages of these plans. There are
many, more detailed sources of information about these plans. We
have inserted some links to these other resources at the end of this Article.
[See below.]
Please note - this article has not been updated
since some recent changes to Pennsylvania's plans (November 2006).
How the Plans Work Generally
Section 529 Plans provide advantageous ways for people to save for
college. A person (the account owner) can establish a 529 Plan
account with the sporsoring agency or company and the account owner can
designate a beneficiary on the account. After the account is established,
the account owner makes contributions to the account for the beneficiary.
Generally, the beneficiary may be changed by the account owner
with the approval of the sponsoring agency (in a Pennsylvania plan, with
the approval of the Pennsylvania Treasury). The replacement beneficiary
must be a member of the family of the original beneficiary. Eventually,
the funds can be used for college tuition for the beneficiary.
Tax and Other Advantages
There are various advantages to 529 Plans, some of them tax
related. First, the investment in the account grows free from
income tax. Second, when qualified distributions are made from
certain plans and used toward the payment of qualified education expenses,
the distributions are also income tax free. Third, the account
owner maintains control of the funds and always retains the right to
make withdrawals at any time. Fourth, there may be the opportunity
to lock in tuition rates at certain colleges and universities at today's
rates, as for example in certain Pennsylvania plans. Fifth, Pennsylvania
plans are protected from the claims of creditors. There may be adverse
income tax consequences and penalties for certain non-qualified withdrawals
from the accounts. The tax treatment of Pennsylvania 529 Plans for
non-residents of Pennsylvania does not have all the advantages as for
Pennsylvania residents.
Contributions to a 529 Plan are treated as completed gifts
to the beneficiary for Federal Gift Tax purposes. Making gifts
can be an excellent way for a person to save Federal Estate Tax.
(This Web Site contains a more detailed article on the topic of "Gifts.") The
basic principle is that if a person gives away money or property during
his or her lifetime pursuant to an appropriate plan, the property will
not be in that person's estate when he or she dies and therefore, the
heirs will not have to pay Federal Estate Tax on that property.
Normally, if a person attempts to make a gift, but does not really give
the property away (that is, if he or she retains control over the gifted
property), the property will still be taxed in that person's estate when
he or she dies. 529 Plans are a significant exception to that general
rule. When a contribution is made to a 529 Plan, it is treated
as an asset that belongs to the designated beneficiary for Federal Estate
Tax purposes, even though the account owner retains control over the funds.
Therefore, the account owner's taxable estate is reduced by the amount
of the contributions made to the plan (up to certain maximum amounts),
even though he or she still controls the funds. This is a unique advantage
to 529 Plans.
Because contributions to 529 Plans are treated as completed
gifts for Federal Gift Tax purposes, there are potential Federal Gift
Tax consequences that result from making these contributions.
Generally, gifts (including gifts to 529 Plans) are subject to Federal
Gift Tax. However, the law permits every person to make gifts each
year to an unlimited number of people up to a certain dollar amount per
person. This amount is now $11,000 each year per person. These
gifts are known as "Annual Exclusion Gifts." Therefore, an account
owner can make gifts of up to $11,000 each year to a 529 Plan for any number
of beneficiaries without incurring any Federal Gift Tax. Normally, where
a gift is made to a trust and the terms of the trust do not permit the recipient
to immediately use or withdraw the gift, the gift is not even eligible
as an Annual Exclusion Gift. A gift to a 529 Plan, although the beneficiary
may not be able to use or withdraw it immediately, is still eligible as
an Annual Exclusion Gift. This is another significant advantage
to 529 Plans.
A married couple, for example, a set of grandparents, can
double this annual amount through a process known as "gift splitting",
even if all the funds come from only one of those persons. By following
the appropriate procedures, each spouse is treated as having made
a separate $11,000 gift to the 529 Plan in a given year, permitting
a total of $22,000 to be contributed annually to the 529 Plan for a
beneficiary without paying any Federal Gift Tax. There is also
a method by which an account owner can contribute more than $11,000 (or
$22,000 if splitting gifts) in a given year without adverse gift tax consequences,
by pro-rating a gift over a five year period. This means that an
account owner may be able to make a one-time gift of up to $55,000 (or
$110,000 if splitting gifts) for each beneficiary and treat this aggregate
amount as if it had been made over a five year period. This is
another unique advantage of 529 Plans. A properly prepared Federal
Gift Tax Return must be filed to implement this strategy. Additional
contributions or the death of the person making the contribution within
five years can have adverse gift and estate tax consequences. It
is important that a knowledgeable attorney or accountant be consulted
before implementing a gifting plan, especially a plan involving more than
an $11,000 contribution, to be certain that the contribution takes maximum
advantage of the favorable provisions in the tax laws.
529 Plans also have advantages over the more traditional custodial
accounts (UGMA or UTMA accounts). When a child reaches a certain
age, the funds in a custodial account are no longer controlled by the
custodian but belong to the child. The child could decide to use
the funds for something other than college. The 529 Plan, in contrast,
is always under the control of the account owner, without regard to the
age of the beneficiary.
Pennsylvania Plans
Pennsylvania law specifically provides for Qualified State Tuition Programs,
sometimes called Pennsylvania TAP 529 Plans. Pennsylvania provides
for two types of plans - the Guaranteed Savings Program Fund (the
"Guaranteed Fund") and the Investment Program Fund (the "Investment Fund").
The account owner can establish a Pennsylvania TAP 529 Plan account
with the Pennsylvania Treasury by entering into a "Tuition Account Program
Contract" (TAP Contract).
The Guaranteed Fund comes
with a guarantee - that the account will grow at the same rate that
tuition increases at a beneficiary's chosen institution or tuition level.
Each contribution to the Guaranteed Fund is used to purchase tuition
credits at the tuition level designated by the account owner in the
TAP Contract. When tuition rates increase, the value of the account
increases at the same rate. The Guaranteed Fund enables individuals
to pay for higher education expenses at today's lower prices. Many
(but not all) public and private institutions of higher education participate
in the Guaranteed Plan. A potential account owner should investigate
whether the chosen school participates before establishing an account.
The Investment Fund gives
an account owner flexibility in investment options but has no guarantee.
There is a risk that contributions will not rise at the same level as
a school's tuition rates. However, the account owner may also
reap greater rewards in the Investment Fund because the account may grow
faster than tuition rates. The Investment Fund gives an account
owner the option of taking a more aggressive investment approach or a
more conservative investment approach based on his or her own risk tolerance
level.
Pennsylvania residents are not limited to 529 Plans from the Pennsylvania
Treasury. Many other plans are also open to Pennsylvania residents.
A careful investigation should be made before selecting a particular
529 Plan because there are significant differences in fees and costs as
well as differences in investment returns. A Pennsylvania 529 Plan
may not be the best choice even for a Pennsylvania resident.
Summary
Section 529 Plans may be an excellent way to save money today for the
higher education expenses of tomorrow and can be part of a good financial
plan and estate plan, especially for parents and grandparents.
The technique of making contributions to 529 Plans, as set forth above,
can result in very substantial tax savings. We suggest you consult
with a knowledgeable attorney in the state where you live to help you
decide if a 529 Plan should be part of your own estate plan. We also
suggest that you review the information available at the linked sites as
well as from other sources.
Links to
Other 529 Plan Resources
Pa
Treasury - TAP 529
Guide to Understanding
529 Plans (PFD)
How Stuff Works
- How 529 Plans Work
College Savings Plans Network
Morningstar
Articles About 529 Plans
Merrill
Lynch
SmithBarney
Independent
529 Plan (TIAA-CREF)
Note: The
statements contained in this Article are set forth here for information
purposes only and are not intended to be legal advice. You
should consult a lawyer for legal advice about your own particular
situation. This Article does not attempt to provide all the detailed
requirements of the plans or all the tax consequences that might result
from various circumstances.
We are not responsible for any information set forth at any
of the linked web sites and make no representation about the accuracy
of that information.
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Notice Pursuant to Final Regulations Under Circular
230, effective June 20, 2005
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The opinions contained in any communication on the
web site are not intended or written to be used, and cannot be used, by any
taxpayer for the purpose of avoiding penalties that may be imposed on the
taxpayer under the Internal Revenue Code.
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Revised June 2005
© 2005 Marc H. Jaffe
Fromhold Jaffe & Adams
Attorneys
at Law
Villanova Center - Suite 220
789 East Lancaster Avenue
Villanova, Pennsylvania 19085
610-527-9100
www.fromholdjaffe.com
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