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How Are You Going To Pay for College?

An ever important question from parents is how to save for their child’s college tuition. Section 529 College Savings Plans, covered under Section 529 of the Internal Revenue Code are one of the best options a parent could choose. Qualified withdrawals from Section 529 plans are now completely tax-free as a result of the Tax Act of 2001.

There are choices and limitations to Section 529 plans. National, state, and specific colleges offer plans to help parents save money for their child’s continuing education in a way that provides some strong tax benefits and wonderful savings.


Smart Money Magazine rates Virginia among the nation’s top four states in terms of its college savings plans. These plans offer Virginians many different opportunities to save for a child’s college education.

One option is VPEP (Virginia Prepaid Education Plan) which locks in tuition at today’s prices to cover future tuition and mandatory fees at state colleges and universities. The investment can also be used for private and out-of-state schools, but the program does not guarantee full coverage. VPEP was created as an independent state agency by the Virginia General Assembly in the mid-1990s. The plans are in conformance with Section 529 of the Internal Revenue Code, the set of rules for which the 529-qualified state tuition programs are named. VPEP plans allow for monthly payments and have some great tax benefits.

More growth potential may be found in VEST (Virginia Education Savings Trust) which uses a mix of stocks and bonds to invest for education. VEST portfolios can either be age-based or "non-evolving", ranging from conservative to aggressive. These mutual funds contain a constant mix of stocks and bonds and can be changed once a year. Aggressive funds are 80% stocks, 20% bonds; moderate funds are 60% stocks, 40% bonds; and conservative funds are 20% stocks, 80% bonds. A money market fund also is available which is 100% cash. A VEST account is not limited to anyone by age, residence, or income. VEST programs do not involve a financial advisor and do not offer financial advice, but are designed to fit with the child’s age.

Section 529 plans allow contributions to grow tax-free. If used for a qualified education expense, there is no tax imposed on the income that is earned and used to pay those expenses. There are two types of Section 529 plans. A prepaid tuition plan allows parents to lock in current tuition prices at state colleges and universities for their child by paying a lump sum or agreeing to monthly payments, saving them thousands as college tuition go up each year.

College savings plans allow you to make contributions to a state-sponsored savings account and take advantage of many benefits. Any parent or other qualified family member can invest in a Section 529 plan, regardless of income. Depending on the plan you select, contributions can be up to $55,000 in one year or have the gift count as $11,000 contributions for each of 5 years. Your spouse can make a one-time gift of $110,000. Assets in a Section 529 plan can easily be transferred among relatives including a sibling, grandchild, niece, nephew, or cousin if the intended beneficiary chooses not to go to college or the child receives a scholarship. The money invested in a state-sponsored plan can be used at any accredited college or university in the nation. If you do not like the plans that Virginia has, you are able to invest in plans from other states. There is no time limit attached to the plan, so it is fine if the beneficiary takes a few years off after high school.

Each state selects an asset management company that oversees the plan. Some plans have a guaranteed floor and moves your investment through age-appropriate securities. For example, investments for younger children begin in equity-heavy securities, but they move into money market funds or bonds as the child gets closer to entering college. The funds you choose can be changed every 12 months.

There is no up-front deduction for Section 529 contributions but investments do grow tax-free. Qualified withdrawals are exempt from federal taxes. However, if a withdrawal is not qualified the income is taxed. A penalty is not imposed if a beneficiary receives a scholarship or passes away before the money is used, but the income received is taxed. In-state residents get additional benefits by receiving a state tax deduction for contributions up to a certain amount.

Section 529 plans offer advantages over distributions made under the Uniform Gifts to Minors Act (UGMA). Under Section 529 Plans, the parents retain control until the funds are dispersed to the college or university. The funds do not automatically go the child when he or she reaches 18. However, once the child receives their gift, the income level of the child is increased. On the FAFSA form, the government allows for 35% of a student’s income to be allocated for college tuition. Only 5.6% of the parents’ income is allocated to pay for a child’s education. A sizable UGMA donation could hurt a child’s opportunity to get federal grants and loans as the income of the child is increased. Financial aid eligibility is not impacted as greatly under a Section 529 plan because contributions are treated as an asset of the parent, not the child.

Parents should not seriously consider investing in a college savings plan unless they are secure for their retirement. There are always loans, tuition credits, scholarships, and grants to help someone finance college. There are none of these things to help a person once he or she retires and is unemployed for 30 or so years. Parents might want to maximize his Roth IRA contributions if they meet the income limits. These contributions could be pulled out to pay for college expenses without a tax impact or the imposition of a penalty.


There are many advantages to investing in a Section 529 plan, but there are disadvantages. If you make an unqualified withdrawal from a Section 529 Plan, you will owe a 10% penalty in addition to having to pay both federal and state taxes on the earnings. Know what you are getting into before you make any investment decision.

What Should You Consider When Evaluating a 529 Plan?


  • Who can open an account?

  • Who is treated as the account owner?

  • Does the owner or student have to be a state resident?

  • Are there any age restrictions on who can open an account?


  • At which schools can the account funds/benefits be used?

  • What college expenses are included in the plan?


  • What happens if the beneficiary does not attend college?

  • What is the procedure for changing a beneficiary? Who is eligible?

  • What happens if the beneficiary dies or becomes disabled?

  • What happens if the child receives a scholarship?


  • How long the funds can remain invested in the plan?

  • What are the minimum and maximum contributions allowed (annual and cumulative)?

  • What is the penalty on nonqualified distributions?

  • Are rollovers allowed to/from other state 529 programs? What are the terms?

  • What happens to account ownership in the event of death or divorce of the owner?

  • Can the owner get a refund of the account? If so, what are the terms?

  • Is there a limit on the number of credit hours a student can take when he or she enters college?


  • Can contributions be made through an automatic electronic fund transfer from a payroll or bank account?

  • What are the enrollment and account maintenance fees?


  • What are the investment options? Are these compatible with the client’s risk tolerance?

  • Who is the investment manager?

  • What are the fees associated with the manager?

  • How are distributions made?


  • Are contributions deductible for state tax purposes?

  • Are account earnings subject to state income tax and if so, when?


  • How does the account affect financial aid eligibility for both the student and the parent?

  • Does the plan allow accounts set up under the UGMA/UTMA?




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