Tax Issues

The Texas Guaranteed Tuition Plan (TGTP) cannot provide investment or tax advice, and the following information should not be construed as legal, financial, or tax advice with respect to the consequences for any particular individual as a result of the purchase of or distribution from a TGTP prepaid tuition contract. This information is not a substitute for discussing your particular situation with a tax professional or the Internal Revenue Service (IRS).

Are there tax advantages with this plan?

Contributions to a prepaid tuition plan may qualify for the annual $13,000 per person exclusion from gift tax. For estate tax purposes, prepaid tuition contributions are considered to be part of the beneficiary's estate, not the contributor's. This is especially noteworthy to grandparents who may wish to contribute to their grandchildren's prepaid tuition accounts.

Payments made to purchase a prepaid tuition contract are not tax-deductible.

Distributions used for qualified higher education expenses are exempt from federal income tax. This exemption, which was scheduled to expire on December 31, 2010, was made permanent by the Pension Protection Act (H.R.4) of 2006.

NOTE: This discussion is for general informational purposes only and is not a substitute for the advice of a qualified tax advisor. These provisions may change through subsequent tax rulings or federal legislation. Consult your tax advisor about other tax benefits or consequences the program would have for you.An individual should carefully review the related Internal Revenue Code sections when consulting his or her tax advisor.

What are some of the federal tax ramifications of the Hope tax credit, Lifetime Learning credit, traditional IRAs, Roth IRAs, Series EE US savings bonds, and 401(k) retirement plans affecting the prepaid tuition contract?

When the beneficiary uses his/her prepaid tuition account for college, and the requirements of household income are met, the beneficiary or beneficiary's parents may claim the Hope tax credit or Lifetime Learning Credit on their tax return. However, coordination will be needed to avoid a tax penalty on Texas Guaranteed Tuition Plan earnings when individuals claim either of the education tax credits and use the Texas Guaranteed Tuition Plan. See chapter 8 of IRS publication 970 "Tax Benefits for Education" for a detailed discussion of the coordination necessary between education tax credits and distributions from a qualified tuition program. An electronic version of the publication is available at the IRS Web site or you may request a printed copy by calling 1-800-829-1040.

A contract purchaser who is younger than 59 1/2 who withdraws funds from a traditional IRA or 401(k) plan to pay for a prepaid tuition contract will be subject to the ten percent excise tax as well as additional income tax on the withdrawn funds. If Roth IRA funds are used to purchase a prepaid tuition contract by an individual who is younger than 59 or in the first five years of the Roth IRA, the purchaser will be subject to a ten percent excise tax and additional income tax on the earnings withdrawn from the Roth IRA.

If a person cashes in Series EE savings bonds and uses the proceeds to pay part or all of the purchase price for a Texas Guaranteed Tuition Plan prepaid tuition contract benefiting the holder of the bonds or that person's spouse or dependent, the interest earned on those bonds will be tax exempt. However, the tax exemption for the interest is phased out if the bondholder's modified adjusted gross income exceeds certain limits for the year in which the bonds are cashed.

NOTE: This discussion is for general informational purposes only and is not a substitute for the advice of a qualified tax advisor. Any person planning to sell Series EE bonds, or using the distributions of an IRA, Roth IRA, Coverdell Education Savings Account, and 401(k) to pay all or part of the purchase price of a Texas Guaranteed Tuition Plan prepaid tuition contract should carefully review the related Internal Revenue Code sections and consult his or her tax advisor. These provisions may change through subsequent tax rulings or federal legislation. Consult your tax advisor about other tax benefits or consequences the program would have for you.

Can distributions from a Coverdell Education Savings Account be used to pay for a Texas Guaranteed Tuition Plan Contract?

Yes. Funds held in a Coverdell Education Savings Account may be withdrawn to make payments on a Texas Guaranteed Tuition Plan contract without incurring federal income taxes or penalties on the distribution.

May I purchase a Texas Guaranteed Tuition Plan contract and also contribute to a Coverdell Education Savings Account?

Yes. Individuals may purchase a Texas Guaranteed Tuition Plan contract and also contribute to a Coverdell Education Savings Account in the same year for the same beneficiary.

NOTE: This discussion is for general informational purposes only and is not a substitute for the advice of a qualified tax advisor. Any person planning to sell Series EE bonds, or using the distributions of an IRA, Roth IRA, Coverdell Education Savings Account, and 401(k) to pay all or part of the purchase price of a Texas Guaranteed Tuition Plan prepaid tuition contract should carefully review the related Internal Revenue Code sections and consult his or her tax advisor. These provisions may change through subsequent tax rulings or federal legislation. Consult your tax advisor about other tax benefits or consequences the program would have for you.