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August 21, 2005 - With the school year approaching I am realizing my kids are growing up and will be in college sooner than I know it. I have heard that 529 plans are one option to save for my kids' college, but can you fill me in on the details?

Sure. There are two types of programs: prepaid plans, which allow you to buy tuition credits or certificates at present tuition rates, even though the beneficiary (child) won't be starting college for some time; and savings plans, which depend on the investment performance of the fund(s) you place your contributions in.

You don't get a federal deduction for the contribution, but the earnings on the account aren't taxed while the funds are in the program. You can change the beneficiary or roll over the funds in the program to another plan for the same or a different beneficiary without tax consequences.

In Colorado however, the contributions that you make to the Colorado-sponsored state tuition saving plan known as Scholars Choice are a deduction on your Colorado income tax return. Colorado also established a prepaid tuition program in 1996 but has since closed that option to new members.

Distributions from the program are tax-free if they don't exceed the student's qualified higher education expenses. If the program was established by a private education institution (rather than a state), the distributions are tax-free beginning in 2004.

Qualified higher education expenses include tuition, fees, books, supplies, and required equipment. Reasonable room and board is also a qualified expense if the student is enrolled at least half-time.
Distributions in excess of qualified expenses are taxed to the beneficiary to the extent that they represent earnings on the account. A 10% penalty tax will also be imposed.

Accredited colleges, junior colleges, and area vocational schools are qualified to participate in the tuition program. Accredited post-secondary schools offering credit towards a bachelor's degree, an associate's degree, a graduate or professional degree, or another recognized post-secondary credential, are also eligible to participate, as are certain proprietary institutions and post-secondary vocational schools.

The contributions you make to the qualified tuition program are treated as gifts to the student, but the contributions qualify for the annual gift tax exclusion, which is $11,000 for 2005. If your contributions in a year exceed the exclusion amount, you can elect to take the contributions into account ratably over a five-year period starting with the year of the contributions. Thus, assuming you make no other gifts to that beneficiary, you could contribute up to $55,000 for each beneficiary in 2005 without gift tax. (In that case, any additional contributions during the next four years would be subject to gift tax, except to the extent that the exclusion amount increases.) You and your spouse together could contribute $110,000 per beneficiary, subject to any contribution limits imposed by the plan.

A distribution from a qualified program isn't subject to gift tax, but a change in beneficiary or rollover to the account of a new beneficiary is.

More information on Colorado’s 529 plan is available at collegeinvest.org, and for 529 plans in general see savingforcollege.com.

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