529 plans aid in planning for education expenses

Though you may be ecstatic about your new adventures in parenting, it doesn’t take long for you to realize that nothing could have prepared you for such an undertaking. Sleepless nights and diaper dollars are just the beginning.

Once the shock fades and you begin to settle in as a new parent, there are some things you can do to prepare for your financial future and make things easier for you and your child. After the early years have passed and as your family matures, universities from across the nation will be sending shiny pages of marketing material to your home.

Even if all you can think about now is bottles and baby food, the days of college courtship will come quickly. And because it may be one of the biggest expenses faced by a new parent, it is important to begin saving for college expenses as soon as possible.

With the average public university costing upwards of $5,985 per year, and private university tuitions costing on average $20,952 a year, you will need to be prepared. You should also expect hefty price increases by the time your children are ready for college.

To soften the blow, you might consider investing in a 529 college-savings plan. No matter what type of investments you choose, any earnings from the money contributed to a 529 plan will accumulate tax-free until they are withdrawn for college costs. As an additional benefit, some states also offer state income tax deductions on the contributions. There are no income or age restrictions for participation in a 529 plan, but there are limits to the amount that can be contributed before the gift tax penalties apply.

Couples can contribute up to $120,000 in 2006 per child, and single taxpayers can contribute up to $60,000. It is important to remember that this amount is considered a five-year gift – $12,000 per year – and a portion of the contribution may be subject to estate tax recapture if the donor dies within five years of the gift.

After making this gift, any additional gifts to the same beneficiary in 2006 or the next four years would be considered reportable gifts.

When it comes time for freshman move-in day at the dorms, not only will you be thankful for years of preparation, you also may appreciate the withdrawal advantages of a 529 plan. Distributions from 529 plans for qualified expenses, including tuition, fees, books, supplies and room and board, are free of federal income tax, and, in some states, free of state income taxes as well. It is important to remember that if you do not use the assets in the plan for qualified higher education expenses, earnings on such withdrawals are taxed at the recipient’s rate plus a penalty of 10 percent on the earnings.

Another issue to remember is that there is a sunset provision that expires Dec. 31, 2010, meaning that instead of tax-free withdrawals, most qualified withdrawals will go back to being taxed on the earnings portion only, at the recipient’s tax rate.

Keep in mind that the value of your 529 plan investment will fluctuate. When you redeem your shares, they may be worth more or less than your original investment. There is no guarantee that the account will grow enough to cover higher education expenses.

In order to promote further independence and growth, allow your children to contribute to the years of preparation by saving some money, too. Managing money from summer jobs may teach them the monetary responsibility essential for a strong financial future.

Timothy M. Reese is senior vice president-investments with A.G. Edwards & Sons Inc. Member SIPC. He can be reached at timothy.reese@agedwards.com.[[In-content Ad]]