This year, 529 plans, tax-advantaged college investment accounts, are getting better in big ways: grandparents can contribute more without tax implications, plan funds can be used for technology purchases, and investment prices are dropping.
While 529 plans have always been a great way for parents to pay for college, the increased flexibility makes them even better, says Roger Thompson, vice president for enrollment management at the University of Oregon. The IRS is "adding the essentials that make a student successful," he notes, including now allowing parents to withdraw 529 plan funds for students to buy laptops.
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Here are the three 529 plan changes every parent should look for this year.
1. Increased gift tax exemptions: If grandparents want to donate to their grandchildren's 529 plans, they can now give $14,000 annually before they're charged a gift tax, says Jimmy Williams, a personal finance specialist and certified public accountant in Oklahoma.
Last year, the limit was $13,000. Since five years of the exempted amount can be gifted at one time, that's a 5-year donation of $70,000 per grandchild, he adds. A married couple could give $140,000, provided they don't give additional funds to the same grandchild in the 5-year time span, he says.
For example, if a grandparent who has the means to do so contributed $70,000 to each grandchild, he or she wouldn't get taxed. However, if the grandparent decided to give another $1,000 next year, he or she would get taxed on the $1,000, in addition to any other additional gifts during that 5-year period, Williams notes.
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2. Expanded qualified expenses: Last year, families generally couldn't use 529 plan funds for laptops, iPads, Internet service, and software, Williams says. But the IRS is going high tech and realizes these are potentially necessary items for higher education, he says. Parents of a student who receives a full or partial scholarship can now use the funds they've saved for years to enhance their child's educational experience, Thompson notes.
If a parent saved $40,000 for college, but a student only needs $20,000 after grants, scholarships, and tax credits are factored in, they would have half the funds in their 529 plan remaining. Some of this money could be used on technology. In prior years, excess funds would have to be transferred to a student, normally a younger sibling, or eventually be withdrawn with the possibility of incurring a tax penalty, Williams says.
However, families need to be careful about the amount they spend on supplies of any kind, because spending in excess can trigger a federal tax audit. For instance, you might be able to deduct $20 per month for Internet service, but not for a high-end $50 plan, Williams says. Families need to consult with the educational institution's financial aid office or their accountant before withdrawing funds for technology and supplies.
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3. Dropping plan prices: "States are clamping down on management fees for 529 plans, thus putting pressure on plan managers to reduce prices," Williams says. As a result, rates are getting lower for consumers, he says.
Also contributing to this trend is competitive bidding among plan management companies to run 529 plans on behalf of states, says John Heywood, principal for Vanguard's Retail Investor Group.
In the last seven months, Vanguard, a mutual fund company, has reduced prices on three of its full-service plans, in which Vanguard serves as the investment manager and provides investment management and phone support from trained 529 plan representatives. The price for the New York 529 College Savings Program's direct plan was reduced by 32 percent. Expect the downward pricing trend to continue throughout 2013, Williams says.
Trying to fund your education? Get tips and more in the U.S. News Paying for College center.