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September, 2005






















































Money Goals

College Savings Options

Parents and grandparents should take note of the breaks that are provided to individuals who make donations to College Savings Plans (a.k.a. Section 529 Plans…after the Internal Revenue Code Section that created these plans). If the assets set aside in these plans are used for qualified higher education expenses then the earnings are exempt from federal income tax. Qualified expenses include tuition, fees, supplies, certain room and board costs and books. A few states, including Colorado, also exempt the income from state taxation if the assets are used for qualified higher education expenses and/or offer deductions/tax credits for contribution to their plan.

A custodian for a Uniform Transfers/Gifts to Minors Act (a.k.a. UTMA or UGMA) account can liquidate their current investments and transfer assets to these plans; however, donors should weigh the benefits of such a move with the tax cost of liquidating the investments. Also, a UTMA/UGMA custodian who opens a College Savings Plan account does not have the same rights as an individual who opens College Savings Account (e.g., UTMA/UGMA College Savings Accounts can not be transferred to other family members).

To help familiarize you with these plans, we refer you to the following:

  1. A listing of each state's plan and the phone numbers to call for additional information can be found at www.savingforcollege.com.
  2. A chart that compares some of the features of these plans with other college savings techniques is included below.

The following is a brief summary of the major advantages and disadvantages of College Savings Plans:

Major Advantages

  1. Earnings are exempt from federal income taxes if they are used for qualified higher education expenses. (Note: This exemption is scheduled to expire on December 31, 2010. Congress may or may not extend the tax benefits of these plans beyond this date.)
  2. Accounts are transferable to other family members of the beneficiary.
  3. Virtually anyone can contribute to one of these accounts regardless of their income level.
  4. Donors can contribute $200,000 or more to one of these plans in a single year (subject to the state's donor limits). Gift tax rules still apply, though a special gift tax provision allows a donor to consolidate up to five years of gifts (i.e., $55,000 per individual/$110,000 per couple) in one year to each beneficiary through a special election made on the donor's gift tax return.
  5. The donor retains control over the assets even if the assets are not used for higher education expenses. Donor's can withdraw the assets for personal use; however, the earnings would be subject to income tax and a 10% federal tax penalty.

Major Disadvantages

1.
Some states still tax the earnings from these plans when they are withdrawn to pay for qualified higher education expenses. The state income tax liability should be small since the earnings are taxed at the beneficiary tax rate, which is typically lower than that of the donor's.
2.
To receive state-specific tax benefits, state residents often must use the College Savings Plan adopted by their state.
3.
Donors are limited to the investment options that are available within the College Savings Plan that they choose. For example, the Colorado Direct Portfolio plan currently has three age-based investment options and eight fixed portfolios and investors must allocate their contributions to one of those options.
4.

Donors have limited ability to move money between investment options within the plan. For example, some plans limit the number of asset allocation changes per year. There are also a few other ways that an account holder can alter his/her asset allocation.

a.
Donors can move money between state plans once a year on a tax-deferred basis. So, if a Colorado donor was not comfortable with the investment option that he or she selected, the donor could move money to New York's plan on a tax-deferred basis and select new investment options under the New York plan.
b.
Most plans have an age-based asset allocation investment option available that automatically moves their plan's assets to lower risk investments as the beneficiary moves closer to the date that they would attend college. For example, one of Colorado's age-based options allocates 80% to stocks for a 1-year old beneficiary and by age 17 the allocation to stocks is only 25%.
5.
If assets are not used to fund higher education expenses, then the earnings are subject to federal and state income tax and a 10% federal penalty upon withdrawal.

The bottom line is that College Savings plans are a very effective vehicle for individuals to set aside money for the post-secondary education of their children, grandchildren and other family members. Since tax deferral is the primary benefit of these accounts, the earlier you start contributing, the greater the benefits.


College Savings Techniques
Comparison of Key Features
10/31/2004
College Savings Plans (Section 529)
Education IRAs
Uniform Transfer or Gifts to Minors Act Accounts (UTMA or UGMA)
General Operation If assets are used for qualified higher education expenses, earnings are exempt from federal taxes;(1) otherwise tax-deferred and subject to a 10% penalty. States may tax earnings when withdrawn. If assets are used for qualified elementary, secondary or higher education expenses, earnings are exempt from federal taxes; otherwise tax-deferred and subject to a 10% penalty. States may tax earnings when withdrawn. Earnings are taxed at children's tax rates. Kiddie tax rules apply to children under age 14.
States allow tax deduction for contributions?
Yes, in some states
No
No
High income taxpayers eligible to use this option?
Yes
No, phase-outs begin at: In 2004 - $95,000 (single) $190,000 (couple) of modified adjusted gross income.
Yes
Gifts count towards $11,000 per donor annual gift exclusion? Yes. Also, a donor can utilize up to 5 years of annual gift exclusions (i.e. $55,000) in one year through a special federal gift tax election.
Yes
Yes
Limit on how much can be placed in the account? Yes. Varies by state. Can be as much as $200,000 or more per beneficiary.
$2,000 per year
No limit
Assets transferable to other family members of the beneficiary?
Yes
Yes
No
Available through most banks, brokerage firms and other financial institutions? No, each state has its own plan, so options are limited.
Yes
Yes
Can assets be moved between investment options? Yes, but moves are limited.
Yes
Yes
Maximum Account Duration Unlimited, although many states have imposed their own time limits. Until student reaches age 30 Until child reaches legal age (as defined by state).
Who Controls Withdrawals? Owner of the account. Child, once he/she reaches legal age. Child, once he/she reaches legal age.
Note: This chart has been created for the benefit of Litman/Gregory Asset Management, LLC clients. Since tax laws relating to college savings techniques are constantly changing, we recommend that you consult your tax advisor prior to utilizing one or more of these strategies.
(1)This exemption is scheduled to expire on December 31, 2010. Congress may or may not extend the tax benefits of these plans beyond this date.

Life goals. Money goals. In that order.

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