Pursuant to Code Section 529, a state may establish a program under which an individual can create an account to pay the higher education expenses of the account's beneficiary. Earnings on these plan accounts are not taxed until they are withdrawn. Several states, at least one of them in cooperation with a major mutual fund company, have created such plans. Their terms and fees differ, but the most flexible plans allow the account monies to be applied to higher education expenses in any public or private institution in any state, without penalty. Though other state plans may be used by New Jersey residents, withdrawals from the New Jersey plan for higher education expenses have the further advantage of being exempt from New Jersey income tax.
Some plans even allow the donors to take the accounts back.
One drawback of these accounts, though, is that you cannot fully control how they are invested. The terms of the state plan will control the manner in which the account is invested. Certain state plans provide greater flexibility than others. While these accounts offer many attractive tax attributes, including tax deferral, the ability to ultimately tax the distributed accounts at the student's rate, the ability of the donor to take the account back, the acceleration of gift tax exclusions, and an exemption from the estate tax, any investment in them should be undertaken after a thoughtful analysis. The terms of the particular state's plan are critical, and should be carefully considered before a contribution is made.