What follows is a transcript of the video above.
Let’s Try a Practice Question:
If the investment goal is tax-free income from an account that will be used for education purposes, an RR would be disinclined to recommend a
- Section 529 plans
- Qualified tuition program
The answer here is B.
To help answer these types of questions, we must look at the keywords. Every question always has a few keywords, tax-free income, education. Looking at these four options, Coverdell, UGMA, Section 529, and Qualified Tuition Program, they are all going to generate tax-free income. We also know that most of these, if it is an appropriate plan, money will be invested.
Are Section 529 Plans Tax-Free?
Section 529 plan used to be called the college savings plan, but now it is just referred to as an education plan. We can use the 529 money for all educational endeavors up and down the food chain from kindergarten, continuing. If it is a qualified tuition plan or program, the money goes in after tax, which is certainly the case on a 529. Remember these are not retirement accounts. These are education savings plans. The money goes in after-tax and grows on a tax-deferred basis. If these plans are used for the appropriate educational purpose, you can take a withdrawal and that withdrawal would be tax-free.
What Is a Coverdell?
Coverdell is another type of education savings plan. These plans are both funded with after-tax dollars and earnings grow tax deferred. A Qualified Tuition Program is also a Coverdell, it is an umbrella term used in the tax code.
Is a UGMA Tax-Deferred?
The money in a Uniform Gift to Minors Account (UGMA) can be used for education, but there is nothing tax-preferred about UGMA money. The money goes in and after tax, it grows. There is also nothing tax-deferred about this one
either. The point of this question was, that there was no tax-preferred clearly about the proceeds of the distributions from a UGMA account. It is all fully taxable.