Saving for Higher Education Expenses with the UESP

The Utah Educational Savings Plan (UESP) is one of the top rated Section 529 savings plans in the country.  Although contributions (which are required to be in the form of cash) are not deductible, account earnings are exempt from income tax when used to pay for qualified higher education expenses of the account beneficiary at any eligible college, technical school, or university that participates in federal financial aid programs for students.  Qualified expenses include tuition and fees, books, supplies, and required equipment.  “Reasonable” room-and-board expenses are permitted for students enrolled at least half-time.  Account earnings spent on non-qualifying expenses are subject to income tax and a 10% penalty. 

Qualifying expenses are reduced by tax-free educational assistance received, and also by expenses taken into account in determining the amount of the American Opportunity tax credit or the Lifetime Learning tax credit.  In many instances where the student beneficiary is reporting the distribution from the 529 plan, it makes more sense to pay the tax and penalty on the distributed account earnings in order to allow all of the expenses to be considered for the tax credits, some of which are refundable!  It is important to prepare the tax return both ways (with the 529 plan exclusion and again without the exclusion but with the credits) in order to see the best tax outcome. 

In addition to the income exclusion, for Utah residents, a tax credit of 5% on the first $1,900 contributed for a beneficiary is permitted for a single filer, and 5% on the first $3,800 for joint filers.  Multiple credits can be claimed for multiple beneficiaries.  However, the beneficiary must have been age 18 or under when the account was first opened to qualify for the credit, and once qualified, the credit will continue to be available for contributions after age 18.  These dollar amounts are for 2015 and future amounts are indexed for inflation.  Previously claimed Utah credits may be required to be recaptured if funds are spent on non-qualifying expenses. 

Section 529 plans are the only type of account where the donor can act as the account owner and maintain control over the funds and still have the gift excluded from the donor’s taxable estate.  The donor can even take the money back, although the earnings would be taxed and subject to penalty.  The annual exclusion from gift tax is $14,000 for 2015 and 2016.  A tax election permits the donor to make up to 5-years’ worth of gifts to a Section 529 plan account in a single tax year.  Therefore, a donor could quickly build up college savings for a beneficiary by contributing $70,000 at once.  If married, the spouse could also contribute $70,000 to the same account.  The election treats the lump-sum gift as a series of five equal gifts over five calendar years.  A gift tax return, Form 709, must be filed to make the election.  Gift tax returns for the four subsequent years are not necessary, unless more gifts are made to that beneficiary.  In such a case, the additional gifts are taxable and will consume a portion of the donor’s lifetime exemption from gift and estate tax. 

Section 529 plan accounts can only change their investment selection twice in a 12-month period.  The UESP provides many investment selections, including a self-designed age-based allocation.  Several accounts can be created for the same beneficiary if you need more investment flexibility.  In 2015, the maximum total balance permitted for any one beneficiary is $416,000. 

Recent planning innovations have promoted using 529 savings plans to accomplish major gift and estate tax planning objectives, where 529 plans might be considered in place of split-interest trust and charitable giving vehicles.  A subsequent blog post will introduce some of these ideas.