May 2001 On-line Tax Planning

Saving For College
- Indiana Section 529 Plan -

Includes Important Update!
(located at the bottom of this article)

Planning and saving for future college education expenses can be a traumatic and daunting task.  In the past, almost all means by which people saved for college were with after-tax dollars.  That is, first you had to pay Uncle Sam and Uncle Frank (Governor O'Bannon) out of your earnings and invest what remained.

Over the past few years, a new tax-advantaged plan to save for college has been devised.  It is a state-sponsored plan commonly referred to as Section 529 Plan.  The state of Indiana has adopted such a plan and named this the Indiana Family College Savings Plan.  The state of Indiana sponsors the Plan and, under contract, Bank One administers it.

The plan allows parents, grandparents, guardians or others to invest money through Bank One in a wide array of investments.  You have two types of plans from which to choose:

The Indiana Plan allows two choices for the investor in the savings program.  The first allows the investor to have their funds invested in mutual funds selected by the State and whose investments vary depending upon the child's age.  Until the child turns 12, the mutual funds selected are weighted toward stocks.  After age 11, the funds are transferred to mutual funds, more heavily weighted bonds and money market funds.  This strategy allows those with a longer investment horizon to strive to benefit from higher anticipated returns in stock investments, and conversely, those with shorter investment time periods can invest in less volatile, more conservative investments.

The second choice lets the investor select her own mutual funds.  The overwhelming majority of participants do not choose this option, but it does remain available for the more informed investor.

The big advantages of the Section 529 Plan are four-fold:

1. federal income tax on the investment's earnings is deferred until withdrawal of funds occurs;

2. upon withdrawal, the earnings are taxed to the beneficiary (the student) whose tax rate is usually lower than the parent's rate;

3. the value of the investment in the Plan is excludable from the contributor's gross estate; and,

4. the state of Indiana does not tax the earnings upon withdrawal if the proceeds are used to pay higher educational expenses.

If the funds are ultimately withdrawn to pay for college tuition, books, fees, supplies, equipment, and room and board, or for vocational-technical school costs, then all benefits of Section 529 accrue.

If the child for whom the account is originally designated does not use the funds, then the unused portion can be rolled over to an account for a sibling or other family member without loss of Section 529 benefits.  If the funds are withdrawn and not used for higher education expenses, then the proceeds are taxable to the contributor, plus a 10% penalty.  But at least the funds are available and enjoyed the benefits of tax deferral for some period of time.

Most state plans will allow out-of-state residents to participate.  So, for example, an Indiana resident can establish a 529 account through the state of Ohio.  However unlike an Indiana participant in the Indiana plan, withdrawal of funds from the Ohio plan (or any other state's plan) will subject the earnings to Indiana tax for that Indiana resident.

You can get an enrollment kit for the Indiana Plan by calling 
(888) 814-6800.  Presently, enrollment in the Indiana Plan can only be done through Bank One.  Some time in the future, you might be able to enroll in the Indiana plan through your stockbroker.  You are presently able to enroll in other states' 529 plans through your stockbroker, but distributions of earnings from those plans will not be exempt from Indiana tax.

Contact your Bucheri McCarty & Metz accountant if you would like additional information. 

Important Update

The Economic Growth and Tax Relief Reconciliation Act of 2001, signed by President Bush on June 7, 2001, makes a significant change to Section 529 Plans.

Generally, distributions from 529 plans made after December 31, 2001 will be completely tax free (i.e., not taxed to the account owner or beneficiary) to the extent the monies are used to pay for qualified higher education expenses.  This is a significantly positive change.
 

Tax Planning Archives

For More Information Contact:

Bucheri McCarty & Metz LLP
2366 W. Boulevard
P.O. Box 2147
Kokomo, IN  46904-2147

Telephone: (765) 236-2300
FAX: (765) 236-2333
Internet: info@bmmcpas.com