Enhanced education incentives.

• Author: Hill, Kevin C.

The cost of higher education has been spiraling ever upward. Fortunately, Congress has recognized this dilemma and attempted to implement solutions that will offer savings and tax incentives for pursuing a higher degree. Unfortunately, these solutions were part of the bill recently vetoed by President Clinton.

Under current Sec. 529, a qualified state tuition program is tax-exempt and individuals are allowed to contribute to an account established for the sole purpose of paying the higher education expenses of a designated beneficiary.

To qualify for the exemption, neither the contributor nor the beneficiary may direct how the account assets are invested (Sec. 529(b)(5)). In addition, the program must provide adequate safeguards to prevent excess contributions from being made for the beneficiary (Sec. 529(b)(7)). Further, the qualifying program must maintain a separate accounting of each beneficiary.

Although earnings generated from such accounts are generally tax-exempt for state tax purposes, they were only tax-deferred for Federal purposes. However, Congress has considered enhancing the benefits of Sec. 529 plans and implementing a few other educational benefits; it introduced a bill that would allow for a Federal tax exemption (rather than a tax deferral) for earnings in a qualified Sec. 529 plan. If enacted, the bill would give a major boost to the popularity of such plans. The exemption would only apply to the extent that a withdrawal is used to pay for qualified expenses, including tuition, fees, supplies, room and board and books. If nonqualified withdrawals were to be taken from a Sec. 529 plan, the earnings would be taxed to the distributee. The bill would grandfather current Sec. 529 plans to qualify for tax-exempt status.

The proposed bill would extend Sec. 529 tax-exempt status to prepaid tuition plans (not to savings plans). It would allow educational institutions (including private colleges and...