The NC 529 Plan

July, 2011
by Gerald Townsend, Financial Editor

There are many ways of saving money towards your children’s or grandchildren’s future college costs. For example, you could just save or invest money in your own name with the intention of using it for those college costs. However, aside from the fact that money saved in such an informal way is likely to be used for other purposes, there are no special tax incentives for saving in this manner.

Because of the above limitations, tax-favored educational funding strategies have long been popular. The old reliable method was to establish a “uniform transfer to minor’s account” (UTMA) and it is still a useful technique, although its usefulness has been reduced due to the “kiddie tax,” which is triggered when a minor has too much investment income.

The Educational Savings Account is another tax-favored educational funding approach, but since you can only contribute $2,000 per year per child, significant accumulations for college are difficult.

529 Plans also have a contribution limit, which varies by each plan, but is commonly more than $300,000, so for most people that is not an issue. 529 Plans are established by individual states and you can invest in a 529 Plan of any state – you do not have to be a resident of a particular state to utilize its 529 Plan.

Since residents of NC can invest in 529 Plans of any state, why should they consider using the NC plan?

The investment options of the NC Plan are OK, but not great. There are a reasonable number of investment choices, but not as many – or as much variety – as some other plans provide.

The NC Plan does have reasonable fees and expenses. It is a “direct-sold” plan, so there are no commissions paid to brokerage firms. There are some no-fee investment choices, such as a FDIC savings option, and the mutual funds used are Vanguard Funds, a well-known manager of low cost index funds.

What makes the NC 529 Plan an interesting educational funding option for NC residents is the ability for NC residents to claim a tax deduction on their NC income tax return for contributions to the plan. This deduction is not available if a NC resident contributes money to a 529 plan sponsored by another state.

The deduction is limited to $2,500 per year on an individual return or $5,000 per year on a joint return. You can, of course, invest much more than this in the NC 529 Plan, but your tax deduction is limited to $2,500 or $5,000 per year. How valuable is this deduction? Assuming a 7% NC income tax bracket, a $5,000 deduction saves $350 in NC income taxes.

Keep in mind that this is an annual tax savings. So, over a 10-year funding period, $3,500 in NC taxes could be saved.

While the flavor of the NC 529 Plan may be vanilla, the tax savings does add a drop of chocolate on top.

Gerald A. Townsend, CPA/PFS, CFP®, CFA® is president of Townsend Asset Management Corp., a registered investment advisory firm. Email: Gerald@AssetMgr.com