Saving for college has some new changes. There are new changes to pre-paid tuition plans and 529 plans, two popular vehicles Americans use to save for and pay for college.The biggest changes are those that pertain to the “kiddie tax.” Effective in 2006, the new law calls for the “kiddie tax” to remain in effect until a child turns 18. Previously, unearned income attributable to children age 14 and older was usually taxed at the child’s tax rate. The new tax law, however, raises the age to 18 effective January 1, 2006.This change affects parents and grandparents who were using or continue to use custodial accounts such as UTMAs (Uniform Transfer to Minors Act) or UGMAs (Uniform Gift to Minors Act) for college savings instead of 529 college savings plans. Right now trust assets for children are factored in determining whether the child is eligible for financial aid. Assets in UGMA and UTMA accounts become the child’s at the assets in UGMA and UTMA accounts become the child’s at the age of maturity, which varies by state.The new law makes 529 plans a more attractive for families saving for college. In a 529 plan, contributions will grow tax-free and withdrawals are tax-free through 2010 as long as they are used for qualified education expenses. These monies are controlled by the grantor until the beneficiary reaches the age of majority.
UTMA or UGMA assets can be invested in a 529 plan but assets need to be liquidated and cash invested in the plan. This could cause a sizable taxable event. However the benefits of converting trust assets to a 529 plan format can be substantial. This is because the 529 has some preferential treatment when a futures student is evaluated for financial aid. (Note: Tax implications should be analyzed before making a conversion.) Under the federal financial aid rules, college savings plans are counted as an asset of the parent (if the parent is the account owner) and assessed at a rate of 5.6 percent. This small ratio does not interfere with a student applying for financial aid.
Some parents and grandparents who have been using prepaid tuition plans to save for their children’s college education. On July 1, 2006 the federal government began treating 529 prepaid tuition plans the same as 529 college savings plans for financial aid purposes. This is great news.
Withdrawals from a college savings plan that are used to pay the beneficiary’s education expenses are not counted as either parent or student income. Prepaid tuition plans will now be treated the same way.
It appears that the government is doing something to aid savers in paying for their loved ones every increasing college costs.
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