College Savings Plans Revisited 2/25/07

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College Savings Plans Revisited 2/25/07

Stewart H. Welch III, CFP, AEP
Founder, The Welch Group, LLC

College Savings Plans Revisited

“529 College Savings Plans Revisited”



Several changes in federal tax laws have strengthened the case for using 529 Savings Plans for college funding.  The Pension Protection Act of 2006 made permanent the law allowing tax-free withdrawals from these plans when the funds are used for qualified education expenses.  The Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 shields 529 assets from would-be creditors once the funds have been in the 529 plan for two years.  Finally, the Tax Increase and Protection Act of 2005 extended the ‘kiddie tax’ from age 14 to age 18.  This tax law change means that children who have investment income of more than $1,700 have that income taxed at their parent’s tax rate which, in effect, makes custodial accounts less attractive for parents wishing to gift assets to children.


With more reasons than ever to consider 529 plans to fund college savings, it’s worth reviewing the strengths and weaknesses of such plans.  Advantages of these plans include:

  • Your money grows on an income tax-deferred basis.  Whether you are earning interest, dividends or capital gains, there is no current taxation.
  • To the extent you use the funds for qualified college expense, withdrawals are tax free. 
  • The donor, typically a parent or grandparent, retains control of the funds.  This is not the case with a custodial account where the child takes ownership and control at the age of majority.
  • You can make substantial gifts without the imposition of gift taxes.  Currently, the law allows gifts of up to $60,000 ($120,000 for couples) without gift taxes.  In reality, you are being allowed to make up to 5-years of annual gift limits in a single year.  TIP: This means that additional gifts may be subject to gift taxes.
  • The donor can retrieve funds for his or her own purposes if needed (see disadvantages below).


There are disadvantages as well:

  • Many plans are heavily laden with expenses including mutual fund fees, sales commissions as well as administrative fees. 
  • While the donor retains control over the 529 plan accounts and can therefore withdraw funds for his or her own purposes, any such withdrawals are subject to income taxes plus a 10% federal penalty on investment gains.


How do you decide which plan is best?  My firm has spent time reviewing the various plans and has determined that Utah‘s plan is one of the most competitive.  Utah‘s plan investments are managed by legendary low-costs fund company, Vanguard.  Note that some state’s plans give a state income tax deduction for contributions by that state’s residents.  Alabama is not one of those states but if you live in a state that does offer a deduction, consider making your initial contribution in your state’s plan and then transferring your funds to a low expense plan like Utah‘s after 12 months.  Be careful that the plan you sign up for does not impose surrender penalties for transfers as do most plans that are sold by commission salespeople.  For detailed research on all 529 plans, go to the ‘Resource Center‘ at and click on ‘Internet Guide to 529 Plans’.