LSAT Reading : Other Effects of New Information in Law Passages

Study concepts, example questions & explanations for LSAT Reading

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Example Questions

Example Question #11 : Law

"529 College Savings Plans"

Section 529 of the Internal Revenue Code encourages saving for future college costs through a kind of tax-advantaged savings account. A 529 plan describes a program establishing savings accounts for all manner of college costs in which the account holder trades investment risk for the prospect of growing the balance. As with all securities, novice investors should consult with a licensed broker before investing money in a 529 plan.

A 529 college savings account comes into existence when an investor chooses a plan and names a beneficiary. States drove the creation of this investment vehicle in response to rising education costs and still manage the investment funds for all 529 plans. Brokers come into the picture when selecting a plan since an account holder need not be a resident of the state managing it. Plans offered by individual states differ, but all benefit from favorable federal tax treatment.

However, securing the tax benefits requires professional care. Section 529 shields contributions to plan savings accounts from federal income taxes up to an annual limit of $14,000 for each beneficiary. The money remains tax-exempt as long as it goes to pay for “qualified higher education expenses,” a definition which now includes computer and internet costs. A withdrawal from a 529 account for any other purpose will likely trigger federal tax liability and a 10 percent penalty.

For his or her part, the beneficiary enjoys a passive role in the investment process. The account holder controls the investment strategy and can choose to allocate funds to conservative or aggressive growth options. Many state 529 plans offer something similar to a retirement pathways account that becomes more conservative as the beneficiary gets closer to the anticipated date of college enrollment. A professional broker can help navigate the options.

A broker can also help an investor avoid missteps after the account is created. Unlike with retirement accounts, federal tax law restricts investment changes to one per calendar year. An account holder can change the beneficiary of a 529 plan or rollover unused funds to a new beneficiary without penalty, but only if the original and new beneficiaries are related. The state agency managing a 529 plan may place additional restrictions on changing the account.

Finally, it is important to have guidance fitting a 529 account into the overall strategy for paying for college. A beneficiary can use 529 plan funds for the same broad purposes as financial aid. As a result, it may reduce the beneficiary’s eligibility for need-based grants or loans.

Of course, using a broker will increase the transaction costs. A broker who helps the account holder navigate to the best state plan will charge a transaction fee or “load.” The broker can shift the load to various phases in the investment process in order to optimize the cost depending on how long the account holder plans to keep the investment.

Assume that an investor, Bob, created a 529 plan for his son who now plans not to attend college. Which choice of action by the investor would not trigger taxes or penalties as explained in the passage?

Possible Answers:

Roll the balance over into Bob’s tax-deferred retirement account

Name another child as beneficiary

Withdraw some money to buy a boat for the beneficiary

Withdraw some money to take a community college course himself

Name a random inner-city youth as beneficiary

Correct answer:

Name another child as beneficiary


Correct answer: The investor can only withdraw money from a 529 college savings account for the qualified education expenses of the named beneficiary. Paragraph 5 states that a new beneficiary can be named without penalty if that person is related to the original beneficiary.

Wrong answers: Retirement saving is not an education expense for the benefit of the named beneficiary, as discussed in Paragraph 3; A boat is clearly a non-educational expense; Community college courses sound like a qualified higher education expense, but the named beneficiary is still Bob’s son; According to Paragraph 5 changing, the beneficiary to a random person will trigger penalties (unless that person happens to be related to the original beneficiary).

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