Give the Gift of Education

Author: Carol Mulcahy, Post Date: December 22, 2008

Carol Mulcahy is a Client Relationship Manager at Cumberland and a Chartered Retirement Plans Specialist SM designee. She was recently approved to be an arbitrator with FINRA.  She has over 23 years experience in the banking and investment industry both in retail and institutional sales and marketing.  Her bio can be found on Cumberland’s home page,  She can be reached at

It’s never too early to start saving for college. So when thinking of gift giving by year end, think of your grandbabies, your children, nieces or nephews, and give the gift of education.

History of the 529 Plan

As many other investment vehicles are named after the Internal Revenue Code in which they appear, this one is no different: IRC 529 was first introduced to us by Congress in the Small Business Job Protection Act of 1996.  It has had modifications over the years, including the Economic Growth & Tax Relief Reconciliations Act of 2001 (EGTRRA), which made it more attractive by allowing distributions for qualified higher-educational expenses to be federally tax exempt. Most recently, the Pension Protection Act of 2006 made this tax exemption permanent.  The federal tax exemption for the 529 Plan was due for a sunset provision in 2010, and many were skeptical of investing for the long term until the exemption was made permanent in 2006. 

What is the 529 Plan?

A 529 Plan is a tax-advantaged college savings plan. It allows the earnings derived from contributions made to an account from the account owner (participant) for a beneficiary to grow tax deferred and ultimately income tax-free, provided they are used for qualified higher education expenses at an eligible educational institution. It is a revocable gift (participant retains control of assets) and can be taken back if needed at a later date (certain rules apply to this, check with plan manager).  In most cases, the student’s choice of school is not impacted by the state in which the 529 Plan was established.  So in the case of a family moving from one state to another or a grandparent opening an account in their own state, as opposed to the beneficiary’s state, state residency should have no impact on the choice of school.

The 529 Plan can be used for accredited U.S. (and selected foreign) private and public colleges or universities, graduate schools, junior colleges, or vocational/technical schools. 

Qualified expenses usually include tuition, books, supplies, mandatory fees, equipment required for enrollment, room and board, and certain expenses for “special needs” students.

There are two types of 529 Plans

1) Savings

Contributions are made with your after-tax dollars (no securities transfer) to the 529 Plan of your choice. Many plans will include mutual funds that offer an age-based asset allocation. This is where the underlying investment will become more conservative as the beneficiary gets closer to the target date of starting college. The risk/performance is directly associated to the performance of the underlying investments. There is no guarantee that the necessary dollars to cover all college costs will be there once the beneficiary goes to college.

The Savings plan is offered for sale in two ways, either Broker/Advisor-Sold or Direct-Sold

Advisor or Broker-Sold Plans

This type of plan is sold through your financial professional.  It means you will get advice on the type of plan and investment options available, but you will also pay commissions and/or fees which may impact your portfolio’s performance.

Direct-Sold Plans

This type of plan is purchased directly from the plan manager. You will need to do your own research and make decisions on what is best for you; however, you would not be paying the commissions you would in the advisor/broker scenario.

2) Prepaid

A prepaid plan allows you to purchase tuition credits or units. You could potentially pay for all or at least part of future in-state public college costs at today’s prices.  Many of these plans can be converted for use for out-of-state schools or private schools. It best to check with the plan you have chosen to see the benefits that will convert over.

One other type of prepaid plan for participating private colleges is the Independent 529 Plan. See link below under “Helpful Sites.”


To avoid federal gift taxes you could invest, for 2008, $12,000 per beneficiary per donor. However, if you choose to take advantage of the special five-year election, you could, for 2008, contribute $60,000 ($120,000 per married couple) per beneficiary without federal gift taxes. This will increase to $65,000 ($130,000 per married couple) in 2009.  This works as long as you do not make any other annual exclusion gifts to the same beneficiary in the five-year election period.  Once the contribution has been made to a 529 Plan, the assets are generally considered removed from the account owners’ (participants’) estate.

For most plans there are no age or income restrictions on giving or being a beneficiary of a 529 Plan. The maximum dollar amount you can contribute may vary from state to state. Remember, we are dealing with sheltering assets and potentially avoiding some taxes; therefore there are some parameters around the maximum dollar amount allowed to be contributed.  It can be realistically based on what a college education is anticipated to cost. Some states will allow over $300k per beneficiary.


A beneficiary can be changed for a variety of reasons. Please check with your plan provider for a list of who qualifies as a “member of the family” to whom the 529 Plan can be changed, without the distribution being treated as taxable.

Distributions not used for qualified expenses are subject to a 10% penalty plus ordinary income tax at your tax rate on the earnings portion.  If you are in a state that allowed for a deduction of a portion of the principal you contributed, you may have to report that “recapture” income on your taxes.  

There are certain cases when the penalty would not apply:

* Death of the beneficiary

* Beneficiary becomes disabled

* Beneficiary receives scholarships, veteran’s or employer-provided educational assistance

Check with your provider for more in-depth details on these exclusions.

Financial Aid Impact

If a parent is the account owner, the 529 Plan is considered their asset and FAFSA (Free Application for Federal Student Aid) will take into consideration only 5.64% of the account value. If the student owns the plan, FAFSA will take 20% of the account value into consideration when calculating awards. If a grandparent is the account owner, this may exclude the plan from reporting on a financial aid application – check with your accountant.

Keep in mind, though, that a lot of financial aid is given in the form of loans, and you will need to pay these back eventually. Loans and loan interest are not qualified distributions under a 529 Plan.

Every case is unique, and each state offers its own form of the 529 Plan. Many have slightly different provisions and state tax implications that make it necessary for you to do research, either on your own or with a financial professional to see which state plan works best for you. We at Cumberland are not tax advisors, we recommend that you consult with your tax professional before investing.

Helpful Sites

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Cumberland AdvisorsĀ® is registered with the SEC under the Investment Advisers Act of 1940. All information contained herein is for informational purposes only and does not constitute a solicitation or offer to sell securities or investment advisory services. Such an offer can only be made in the states where Cumberland Advisors is either registered or is a Notice Filer or where an exemption from such registration or filing is available. New accounts will not be accepted unless and until all local regulations have been satisfied. This presentation does not purport to be a complete description of our performance or investment services. Please feel free to forward our commentaries (with proper attribution) to others who may be interested. It is not our intention to state or imply in any manner that past results and profitability is an indication of future performance. All material presented is compiled from sources believed to be reliable. However, accuracy cannot be guaranteed.