Parents worried about huge college costs have one reason to breathe easier: Withdrawals from Section 529 tuition plans are now permanently free of federal taxes.
One line in the massive Pension Protection Act clarified the uncertainty about these college savings plans. A federal law that allowed tax-free withdrawals for qualified education expenses was put in place in 2001, but a sunset date of 2010 was also set. The pension legislation, which became law last month, removed the expiration date.
"To have that issue put to rest and know that your 529 programs are going to receive the same favorable tax treatment indefinitely is a real victory," said Doug Chittenden, vice president of institutional product management at TIAA-CREF, according to MarketWatch. TIAA-CREF runs 529 programs for several states including Connecticut, Minnesota, Georgia, Tennessee and Vermont.
A 529 plan is similar to a 401(k) retirement savings plan. Every state and the District of Columbia offer at least one 529 plan. There are two types, explains Washington Post columnist Michelle Singletary: prepaid tuition plans and savings plans. A prepaid tuition plan allows people to pay a child's tuition in advance. The savings plan, which is more popular, allows people to invest in a tax-free investment account, she wrote.
“I was a fan of the 529 savings vehicle even when it wasn't a sure thing that it would retain tax-exempt status. Now there's no question this should be an essential part of your college investment plan,” Singletary wrote.
The 529 plans have been popular savings vehicles. The College Savings Foundation estimates parents, grandparents and other investors have stoked 529 plans with more than $77 billion, the Pittsburgh Post-Gazette reported.
Tax experts advise investors to study the plans and be aware of unexpected consequences. For example, the pension bill did not change the existing rules on withdrawals, rules that many people, including CPAs, are not aware of.
“Withdrawals for college tuition and expenses are reduced by tax-free scholarships, fellowships and certain other financial assistance. If the remaining expenses are less than the qualified distributions, part of the earnings will be taxable,” MarketWatch reported.
Rick Darvis, president of College Funding, Inc. and founder of the National Institute of Certified College Planners, said, "You cannot blindly assume that just because you use a withdrawal for qualified expenses, that it's going to be tax free.”
The College Savings Plan Network (www.collegesavings.org) provides links to each state's 529 plan website with details about what plans each state offers.