Advantages of Qualified State Tuition Programs

Qualified state tuition programs that pool your contributions with others and invest them are gaining in popularity every day. Their popularity is not surprising because, while these types of plans have some specific disadvantages, they offer many advantages for those looking to invest for educational purposes.

Tax advantages. First and foremost, withdrawals from the plan used for qualified educational expenses are tax-free. That includes any earnings on the amounts contributed to the plan. You can contribute on behalf of anyone, and there's no income limitation placed on you as a contributor. In other words, unlike a Coverdell Education Savings Account, you can't have an adjusted gross income that doesn't let you contribute or cuts down the amount you can contribute.

And speaking about the amount you can contribute, it can really be substantial. Again, unlike Coverdell Education Savings Accounts, which limit contributions to a maximum of $2,000 a year for each beneficiary, you can contribute a large amount in a lump sum to a qualified state tuition program. When you take into account rising college costs and the power of compounding interest, qualified state tuition programs are a formidable place to put your education investment.

When you make a contribution to a qualified state tuition program it is considered a gift. While, generally, gifts are subject to gift tax when they exceed $14,000 a year or $28,000 per couple (the amount for 2013 and 2014), there's a special exception to the general gift tax rule that applies to contributions to a qualified state tuition program. If a donor's contribution exceeds the annual exclusion amount, then he or she can elect to take the excess into account ratably over five years. However, the contribution is treated as a completed gift for gift tax purposes. While you won't be able to contribute anything for the next four years after you make the initial large contribution, this contribution achieves several very important results. First and foremost, you are able to contribute a large lump sum that begins earning interest immediately. Because the cost of college is high and getting higher all the time, starting off with a large sum whose earnings are compounding is a real boon to any education investment. The fact that you can't contribute for four years after the initial lump sum doesn't negate the benefit of compounding interest on that first-year investment.

Making this type of large contribution is a great estate planning tool as well. For example, if you're grandparents with several grandchildren and you have a sizeable estate; you can reduce your taxable estate by large amounts by making these contributions without incurring gift tax. And remember, those contributions, along with their earnings will be distributed tax-free for education expenses.

Another advantage to the qualified state tuition program is that you can cash in the plan and pay tax and a penalty on the earnings or name a different beneficiary related to the existing beneficiary and essentially transfer the account tax-free. This is a real plus in case circumstances arise where you may need the account proceeds yourself or you feel they won't achieve the result you wanted with the named beneficiary.

Financial aid eligibility. Finally, when it comes to eligibility for financial aid, the funds in a qualified state tuition program are generally considered assets of the contributors, usually parents or grandparents, rather than the student's. This is an advantage in that qualified state tuition programs do not weigh in as heavily in the expected contribution calculation.