Michigan Education Savings Plan, 529 Plan

Release date: February 28, 2007  /  Print This

For more information, contact Ed Pear at 734 665 4441

A Michigan Education Savings Plan (MESP) is a way to invest that has tax-deferred savings opportunities and that removes account assets from the estate of the account owner, while allowing the account owner to control disposition of the assets. This federal income tax-free treatment of qualified withdrawals and other federal tax benefits are now permanently in place for 529 plans through the passage of the Pension Protection Act of 2006. The amount contributed by a Michigan taxpayer to MESP accounts during a tax year, less the amount of any qualified withdrawals from those accounts during that tax year, is deductible from Michigan adjusted gross income in an amount not to exceed $5,000 for a single return or $10,000 for a joint return for that tax year. Amounts transferred from another college savings plan are not eligible for the Michigan tax deduction. See www.misaves.org/faq/tax.html.

1. Who owns the plan?

Under MCL 390.1472(2)(b)(i) an account owner of an education savings account is technically the "[i]ndividual who enters into a Michigan education savings program agreement and establishes an education savings account. The account owner may also be the designated beneficiary of the account."

2. Eligibility for account ownership:

Anyone can be an account owner, typically it is a parent or grandparent type relationship, however this is not a requirement in order to be an account owner. The account owner just needs to be a US citizen, and the account owner does not need to be a state resident, however to get the Michigan tax deduction, obviously the account owner must be a Michigan resident.

3. What if the beneficiary dies?

The short answer to this is that if the distribution is made due to the death or disability of the beneficiary, the earnings portion of such a withdrawal is subject to federal income tax but is not subject to a 10% additional federal tax. No Michigan income tax is due on such a distribution.

The more lengthy and explanatory version of this is that there are, essentially three types of withdrawals that can be made:

a. A qualified withdrawal (i.e., a withdrawal from an MESP account that is used to pay the qualified higher education expenses of the beneficiary¹). The earnings portion of a qualified withdrawal is taken into account when computing the federal income tax liability of the beneficiary. Under Michigan law, no state income tax is due on qualified withdrawals from an MESP account.

b. A nonqualified withdrawal (i.e., if the funds are withdrawn for a purpose other than to pay for qualified higher education expenses). Under federal law, a 10% penalty on the withdrawal amount applies to all nonqualified withdrawals. For Michigan tax purposes, a non-qualified withdrawal will result in income taxation on the earnings portion of the distribution and, to the extent that the account owner has previously taken a Michigan income tax deduction for contributions to the account, the contribution portion of the distribution. However, if an account owner has also made contributions to the account that were not deducted, the contributions portion of a non-qualified withdrawal does not have to be included in taxable income until the account owner has withdrawn all of the contributions that were not deducted. See www.misaves.com

c. Withdrawals resulting from the death or disability of, or scholarship award to. These withdrawals are not subject to the nonqualified withdrawal penalty described above. The earnings portion of such withdrawals, however, is taken into account wished under then computing the federal income tax liability of the account owner. No state income tax is due on these withdrawals, provided that they are from an account established under the Michigan plan.

4. Are earnings tax-free when withdrawn?

As stated above, as long as the earnings are being withdrawn to pay for a qualified higher education expense than the withdrawal is tax-free.

5. Can the account owner change the 529 Plan, i.e., switch among 529 investment options?

Yes. If the account owner wants to reallocate the contribution, the investment options or change the beneficiary the account owner can do that. However, once the account owner invests in a particular investment option, the account owner can transfer the contributions only once in a calendar year. So, if the account owner hasn't taken advantage of this opportunity in 2007, the account owner would have up until December 31 to do so. The opportunity refreshes when the calendar turns over to January 1. Also, if the account owner wants, he or she can change the beneficiary.

6. Do you have to go to a Michigan School?

No, funds can be used at eligible schools nationwide. Whether the beneficiary decides to go to a private or public college or university, in-state or out-of-state, trade or graduate schools, funds in the account may be used at any eligible higher educational institution in the nation and many places abroad. See www.misaves.com. Also, for a list of all the eligible schools nationwide, go to website, http://nces.ed.gov/ipeds/cool/ (COOL: College Opportunities Online Locator).

7. What if the beneficiary changes schools?

It does not matter if the beneficiary changes schools, as long as the school that is being transferred into is an eligible educational institution. The best way to figure this out is to contact the school that the beneficiary wants to transfer into and ask whether they are an eligible educational institution. Generally, eligible educational institutions are accredited postsecondary educational institutions offering credit toward a bachelor's degree, an associate degree, a graduate-level degree or professional degree, or another recognized postsecondary credential.

8. Can the account owner take money out of the account and attach it to another account?

Yes the account owner can take money out of the account if it is for the benefit of the beneficiary's education. Also, if the account owner is withdrawing the money to reimburse oneself for money they gave to the beneficiary than this is legitimate. For all practical purposes, the account owner could take the money out for any reason, there would be no immediate obstacle precluding the account owner from doing this, however if the account owner ever got audited and it was shown that the money was withdrawn for other purposes than the account owner would be in trouble.

9. What are the rights of the beneficiary?

The rights of the beneficiary vary depending on the type of 529 accounts that are at issue. Absent a custodial account, a beneficiary to an individual 529 account really does not have any rights to speak of. In an individual 529 account only the account owner can withdraw the money. However, one benefit to this is that the beneficiary will not be taxed on the qualified withdrawals from the individual account. If it is a custodial account, than once the beneficiary is a registered student the beneficiary has a right to withdraw from the account. However, the beneficiary will also be taxed on the withdrawals from the custodial account.

10. Are there any limits on how much you can pay into the 529 Plan a year?

Technically no, the account owner can contribute as much as he or she wants. However, the amount contributed by a Michigan taxpayer to the account during the tax year is deductible from Michigan adjusted gross income in an amount not to exceed $5,000 for a single return or $10,000 for a joint return for that tax year.

Additionally, something interesting to keep in mind, contributions to 529 Plan may reduce the taxable value of the account owner's estate. Contributions to MESP, together with all other gifts from the account owner to the beneficiary, may qualify for an annual federal gift tax exclusion of $12,000 per donor, per beneficiary for 2007 (or $24,000 if filed jointly). If an account owner's contribution to a MESP account for a beneficiary in a single year exceeds $12,000, the account owner may elect to treat up to $60,000 of the contributions, or $120,000 for joint filers, as having been made over a period of up to five years for federal gift tax exclusion.

11. Can creditors of the account owner reach anything in the account?

No. The 529 Plan is a savings account for the beneficiary, for this reason the account is precluded from being reached by creditors of the account owner.

For more information, contact Ed Pear at 734 665 4441

(1) Such expenses are defined to include only tuition, fees, the cost of books, supplies, and equipment required for the enrollment or attendance of a beneficiary at an eligible educational institution and certain room and board costs if the beneficiary is enrolled with at least a half-time course load.