Under a Section 529 Qualified State Tuition Program Savings Plan, a contributor deposits cash into an account established to meet a designated beneficiary’s qualified higher education expenses. Unlike a Prepaid Tuition Plan which may be offered by a state or college, a College Savings Plan may only be established by a state. To receive tax-exempt status, 529 plans must meet five requirements relating to their operations which are: (1) they can only accept cash contributions; (2) they must provide a separate accounting for each beneficiary; (3) they may not permit either contributors or beneficiaries directly or indirectly to guide the investment of a 529 account's contributions or earnings; (4) they must prohibit the pledging of any interest in a 529 account as security for a loan; and (5) they must provide adequate safeguards to prevent contributions in excess of those necessary to pay the beneficiary's QHEEs. Contributions to a College Savings Plan can only be made in cash as mentioned above and no deduction is allowed for those contributions except in the states of Arizona, Kansas, Maine, Missouri and Pennsylvania. However, there are many tax incentives to contributing to a College Savings Plan. The amount of annual contribution of the plan is unlimited subject to the maximum balance of the beneficiary’s qualified higher education expenses. The earnings in this plan grow tax-free, and distributions from the account are also tax-free, also as long as the distributions do not exceed the beneficiary's qualified higher education expenses. If distributions were to exceed the beneficiary’s adjusted qualified education expenses, the amount would have to be included in the beneficiary’s gross income. With transfers and rollovers, no tax has to be paid when assets from one College Savings Plan are transferred into a second plan for the benefit of the same beneficiary or for the benefit of a member of the beneficiary’s family if the rollover is completed within 60 days after the date of the distribution. A rollover may be made only once every 12 months.
From a gift tax perspective, contributors and beneficiaries receive very favorable tax consequences. Every contribution to a College Savings Plan counts as a gift and qualifies as for the annual exclusion of $13,000 per donee. However, the biggest gift tax advantage of 529 plans is that individuals can contribute more than $13,000 in one year and treat their contributions as if they were made evenly over five calendar years. Therefore, an individual can contribute up to $65,000 to a 529 plan and have no taxable gifts to report.
I highly recommend a College Savings Plan as it is the best option out of all the plans. To reiterate what was said above, three features make 529 plans the best option for college saving. First, with no cap on an individual contributor's income, families at all income levels can take advantage of 529 plans. Second, the ability to accelerate the contributor's annual gift tax exclusion enables families to accumulate a much larger pool of funds by the time the beneficiary attends college. The third, and perhaps the most important, advantage is that the maximum limit on account balances allows families to save enough to pay for college. In fact, because the IRS has given approval in letter rulings, many states are setting limits high enough that beneficiaries could fund a significant part of their graduate education in addition to college. Since costs to attend graduate school also constitute QHEES, distributions from a 529 account to pay for these costs are also tax-free.