by Archie M. Richards, Jr., CFP^®
June 11, 2001

Thanks to the beloved IRS and the various states, saving for education has gotten easier. Named after the applicable IRS Code, "529 Plans" beat custodianships and educational IRAs hands down.

Forty-eight of the fifty states have adopted 529 Plans, most of them available for non-residents. Each one has its own beneficiary. The owner may have plans from different states at the same time.

You can use 529 Plans no matter how high your income. Most states allow lifetime contributions of $100,000 or more to the account of any beneficiary. When a a Rhode Island plan reaches a value of $246,023, sorry, you can't contribute any more.

Contributions must be made in cash, and they're not deductible. But, like IRAs, the earnings within the plan are not currently taxable. As funds are paid out for approved educational purposes, the income accumulations are taxable to the beneficiary. But the 2001 tax-cut bill provides that, beginning in 2002, withdrawals from 529 Plans will be tax free!

As owner, you make the contributions and retain control. You may change beneficiaries, providing the new one is a member of the same family as the old. The definition of family is broad. The mother-in-law of the former beneficiary, for example, qualifies as a replacement. The owner and beneficiary don't have to be related. But the owner and beneficiary may be the same person.

Colleges, graduate schools, and even some vocational schools qualify for payouts. The money may go for tuition, fees, books, supplies and, in limited amounts, for room and board. Payments from 529 Plans are less likely to suppress financial aid than those from custodianships or educational IRAs.

Investments are handled at low cost by the financial institution, such as a mutual fund family, chosen by the state. The specific investments are selected by the institution, not by you. If the one-or-more asset allocation models offered don't suit you, check the plans of other states. Funds from the 529 Plan of one state may be rolled over to that of another.

Contributions are treated as completed gifts, qualifying for the $10,000 annual gift-tax exclusion. Even a $50,000 contribution qualifies for the exclusion if no other gift is made to that beneficiary for five years. If you and your spouse each contribute $50,000 to the plans of each of your four children, bingo, $400,000 is removed from your taxable estates.

Don't delay taking advantage. The IRS likes to hand out tax goodies until significant revenues are lost. Then it closes the door a tad. For more information, read The Best Way to Save for College: A Complete Guide to 529 Plans, by Joseph F. Hurley, CPA. The book describes the features of 529 Plans of each state and offers www.savingforcollege.com as a helpful website.

Regardless of all the above, 529 Plans are lousy public policy. The tax advantages enable tuition costs to remain higher than they otherwise would. Schools with more funds than supply and demand would naturally provide tend to retain poor teachers and hire unnecessary administrators that gum up the works. (Tenure for college professors makes improvements to education all the more difficult.)

For the rich, the tax loophole is mostly offset by the lower quality of the education. For the poor, the plans are a net loss. They can't very well use the tax advantages because they pay little or no income taxes. But their tuition costs are higher than would otherwise prevail. The only group for whom 529 Plans are a net gain are mutual funds, investment advisers, lawyers, and financial planners, who provide the services. All of this widens the gap between rich and poor. As with most big-government policies, the actual long-term results are opposite to the intended results.

Speaking of big government: In Germany, you must have a government license to play golf.

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