Sorting out the Tax Benefits of a 529 College Plan... and It's Never Too Late, Mom!

This week, Gail explains the tax implications of a 529 contribution and says it again: It's never too late to start a retirement plan!

Dear Gail,

I read your article about 529 college savings plans.

I would like to give a gift to my son of $5000. If I put that money in a 529 plan can I consider the $5000 as a gift and deduct that amount as a deductible expense while calculating my income tax?


Dear Dharani,

Unlike contributions to a company retirement plan, money invested in a 529 college savings plan is not tax deductible.

But I hope this doesn't stop you from going forward with your intentions. You get your biggest benefit from a 529 when you take the money OUT. That's because withdrawals used to pay for "qualified" college expenses (tuition, room & board, books, supplies, fees) come out completely free from federal-- and often state-- income tax.

This is a tremendous advantage. For instance, if your $5,000 grows to $20,000, every cent can be used to offset your son's college expenses-- no income tax, no capital gains tax.

So just do it, dad!


Dear Gail,

Is it ever too late to start a retirement plan? My mother just turned 50 and she has been back in the workforce for a few years now. She works for a small law office that does not have any type of retirement plan. 

Should she start some type of retirement plan or should she just put money aside in a savings account for retirement?

Tim C.

Dear Tim,

Great question! Tell your mom it's NEVER too late to set money aside for retirement. (Better yet, print this column and let her read it herself.)

First of all, shame on the attorneys she works for. They ought to have a retirement plan for their firm. In addition to being able to contribute money to their own accounts, there are significant tax breaks available to them as the owners of the business. If your mom is comfortable with the idea, suggest that she ask her employers to look into this for the benefit of everyone at the firm.

Since your mom is over age 50, regardless of what plan the firm adopted, she would be able to contribute an extra amount - called a "catch-up" provision. This year, thanks to the 2001 Tax Act, she could add an extra $1,000 on top of the regular plan limit for a 401(k) or SAR-SEP, for a total contribution of $12,000. If the firm decided to adopt a "SIMPLE" plan - a retirement plan designed specifically for small companies-- she could add another $500, for a total of $7,500. Although it is not labeled as a "woman" benefit, the catch-up provision is a way for someone who has spent time out of the paid workforce (raising children, caring for parents) to make up for years of retirement contributions they were ineligible to make.

There are also ways your mom can save for retirement regardless what her employer does. First of all, since she was not covered by a retirement plan through work last year, she is eligible to make a $2,000 contribution to a traditional IRA and deduct this amount from her 2001 taxable income, thereby lowering her income tax bill. She has until April 15th to make a contribution for 2001.

If the law firm adopts a company retirement plan, she should still continue to contribute to an IRA. In this case, the deductibility will depend upon her salary. (My guess is she would still qualify.) This year you can put as much as $3,000 into an IRA. And IRAs now have catch-up provisions, as well. So her 2002 IRA contribution can be as high as $3,500.

If your mom wants to set aside even more money for retirement, tell her to consider something called a variable annuity (VA). Like an IRA, your mom's contributions will grow on a tax-deferred basis. However, there is no limit on how much money she can put into this account.

There are some additional considerations with VAs. First, a variable annuity is a combination of an insurance policy combined with an investment portfolio similar to a mutual fund. Since they are designed to be retirement vehicles there, is a federal tax penalty if you withdraw money prior to age 59 1/2. In addition, the company managing the VA can impose its own fee if you make a withdrawal from the account in, say, the first six years. Your return will depend upon how well the investments in the VA perform.

Despite the restrictions, a VA offers a major benefit unique to this type of account: the ability for your mom to "annuitize" it. At this point, she is essentially converting the value of the VA into income that the insurance company is responsible for paying to her for as long as she lives. (As an alternative, she could choose to receive a payout for a specific number of years, such as 10 or 15.) Annuitization essentially enables someone who doesn't have an old-fashioned company "pension," to provide one for him/herself.

Moreover, because a VA can be structured to pay income for life, and since women typically live longer than men, annuitization can alleviate one of the big fears they have about retirement: outliving their money.

Please do everything you can to encourage your mom to take advantage of the many tax-favored ways to set money aside for her retirement. I strongly recommend that she - and perhaps with you along for support - visit a financial professional who can put together the best combination of plans for her particular income and objectives.

My best wishes to you both,


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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.