33.5 Contributing to a Qualified Tuition Program (Section 529 Plan)

Qualified tuition programs (QTPs), also known as Section 529 plans, allow you to either prepay a designated beneficiary’s future qualified higher education expenses or to establish a savings plan from which such expenses can be paid. States can sponsor savings plans and prepayment plans. Private colleges, universities, and vocational schools can set up prepayment plans only. Qualified higher education costs include tuition, fees, books, supplies, and eligible room and board costs. Distributions are generally tax free to the extent of qualified higher education expenses (33.6).

In a prepayment plan, a parent or other relative can purchase tuition credits or certificates as a prepayment of a child’s future college costs. Where the child will not start college for many years, prepaying tuition according to a set schedule can avoid higher inflation-based tuition costs down the road. In a state-sponsored savings plan, annual contributions are made to an account for the benefit of the designated beneficiary, earnings accumulate tax-free, and withdrawals can later be made to pay the beneficiary’s qualified higher education costs.

Contribution details and other plan terms including investment options can vary greatly from plan to plan. If you are considering an investment, you should contact the state or educational institution maintaining the plan for details.

Contributions are not deductible for federal tax purposes. However, a state income tax deduction may be available to residents who contribute to a state-sponsored QTP.

You may contribute to both a QTP and a Coverdell ESA (33.11) in the same year on behalf of the same beneficiary.

Gift tax consequences.

A contribution to a QTP is treated as a completed gift of a present interest passed from the contributor to the beneficiary at the time of contribution. Contributions are eligible for the annual gift tax exclusion, which applies separately to each individual to whom you make gifts during a year. For 2012, the per-donee exclusion is $13,000, but if you are married and your spouse elects to split the gift, the exclusion is $26,000 (39.2). If your gift exceeds the annual exclusion, a special gift tax rule allows you to elect on Form 709 (annual gift tax and generation-skipping transfer tax return) to treat contributions of up to five times the annual exclusion as if they were made over five years. Thus, for 2012, you can elect to treat QTP contributions of up to $65,000 (five times the $13,000 exclusion) as if the contributions were made ratably over five years, and this is doubled to $130,000 if your spouse elects to split gifts. If the election is made, you have to report as a 2012 gift on Form 709 only 20% of the QTP contributions up to the $65,000/$130,000 limit, allowing that amount to be offset by the annual exclusion, plus the amount of any contribution exceeding the $65,000/$130,000 limit.