Smart College Savings

Tax Free Withdrawal From 529 Plan Made Permanent

Though almost expected, the new bill certainly removed the last cloud over 529 plan as a valuable college saving tool.

That scenario was avoided last month when President Bush signed the Pension Protection Act. Although the law mainly deals with strengthening the financing rules for defined-benefit pension plans, it also quietly eliminated the 2010 sunset provision for tax-free withdrawals from the popular Section 529 tuition savings plans.

Created in 1996, 529 plans allow after-tax income to be invested in state-sponsored plans and to grow free of federal and state taxes. And thanks to the Economic Growth and Tax Relief Reconciliation Act of 2001, as long as the 529 money is used for qualified college expenses, income earned — capital gains, interest and dividends — can be withdrawn free of federal taxes and most state taxes, too.

But the tax-free withdrawals were set to expire at the end of 2010. If that had happened, “it would have been a real burden,” said David Pearlman, chairman of the College Savings Foundation, an advocate for the education savings industry. “Suddenly, the distributions from the plans would have been taxable, although at the tax rate of the students.”