More on 529s and Small-Company Pension Plans

This week, Gail (again!) encourages parents to set up a 529 college savings plan, and explains the tax implications of SEP ("Simplified Employee Pension") plans. 

Hi Gail,

I would like to know more about 529 ownership. How can I contribute? I have 3 young children and this would surely help.



Dear Vel —

In my opinion, a 529 plan is simply the smartest way to save for college. Smartest in terms of income tax, capital gains tax and estate tax. (I've covered the benefits of 529s in a number of articles. Click on the "archives" tab at the top right of this page and scroll down to Feb. 2, 2002 and Dec. 7, 2001, for instance)

I'm glad you're interested in establishing accounts for your children. As I discussed in my most recent article, "Tax Breaks for College," dated March 1, 2002, money invested in a 529 college savings plan has the potential to grow tax-free, as long as it is used for "qualified higher education expenses."

These would include tuition, room & board, books, fees and supplies. No matter what your tax bracket is, with a taxable account you will still owe taxes on any gains generated each year. You could also be subject to capital gains taxes when you liquidate the account to cover college expenses. So choosing a tax-free strategy is just common sense.

Sounds like you're a few years away from using this, but if you meet the income limits, you can also qualify for either one of two tax credits — HOPE or Lifetime Learning — in the same year you're taking withdrawals from the 529 plan — you just can't take the credit and a tax-free 529 withdrawal for the same college expenses.

Most states now sponsor a 529 plan, so you could start your search by checking out the Web site It has links to every state plan.

However, keep in mind that you don't have to use the plan your state sponsors. Some offer a tax incentive if you do, but if your children are still a number of years away from college, the return your investment could earn over time could more than offset the few hundred dollars you might save in state taxes.

You'll want to make sure the money you invest for your children is managed by a capable money manager (generally a mutual fund company) with a strong track record. Some time this year the number of 529 plans available will reach fifty — one sponsored by each state. And every one has different benefits and restrictions. So you'll also want to check into whether a plan has the flexibility and features you want.

For instance, what is the minimum amount needed to open an account? With some plans it's $15, while others won't talk to you for less than $250. What investment choices does it offer? Can you choose to invest in a fund which automatically reduces its exposure to the stock market as the child's ages as well as individual mutual funds? Or do you get one or the other? What is the annual fee and when is it waived?

Frankly, shopping for the right 529 plan can be overwhelming. And I'd hate to see you get "paralysis by analysis" and delay doing anything. Consider contacting a financial advisor who can help you find the best plan for your situation.

Go for it, Mom!



Hi Gail,

I have a small consulting company where I am the only employee, although my wife may also do some work in the future. The company has incorporated. How can I find information about setting up a SEP retirement or look into other retirement plan options (my accountant said setting up a 401k is very expensive and I would like to keep the costs down).



Dear Dean,

A SEP-IRA or "Simplified Employee Pension" plan was designed for small companies with 25 or fewer employees. Clearly, you qualify. And under the 2001 Tax Act, you can contribute more than ever.

Through the 2001 tax year, a company was restricted to contributing no more than 15% of an employee's salary or $35,000, whichever is less. If you choose, you can subtract company payments to Social Security on behalf of that employee when calculating the amount you need to add to their SEP account.

David Binder, a CPA in Mars, Pennsylvania, points out that if you ran your business as a "sole proprietor," the maximum you could contribute to your own account for the 2001 tax year would be slightly less than that: 13.04%. (This takes into account half the self-employment tax paid.)

However, since you've taken the step to incorporate your consulting firm, it can contribute the full 15%. Naturally, whatever amount your company contributes to your SEP will reduce its taxable income for 2001. I strongly encourage you to open a SEP as soon as possible as it is the ONLY retirement account you can establish at this point for last year. All other retirement plans must have been set up by December 31st, 2001. The deadline for a SEP-IRA is the due date of your corporate tax return, including extensions.

Now is also the time to look into the higher contribution limits allowed for the 2002 tax year. Instead of a 15% limit, the maximum contribution this year jumps to the lesser of 25% of compensation or $40,000. The nice thing about a SEP plan is its flexibility. While you must contribute the same percentage for all employees, you can change this amount each year, depending upon how profitable you are. In lean years you might only be able to contribute, say, 2%. But in gang-buster years, you might want to sock away much more.

When and if your wife joins the company, you will simply open an account in her name.

Smart move, Dean.



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The views expressed in this article are those of Ms. Buckner or the individual commentator, and do not necessarily reflect the views of Putnam Investments Inc. or any of its affiliates. You should consult your own financial adviser for advice regarding your particular financial circumstances. This article is for information only and is not an offer of the sale of any mutual fund or other investment.