Saving for future education expenses is one of the most common financial goals. Whether the beneficiary is a child, a grandchild, or other family member. The preferred “vehicle” for those savings – the type of account – has certainly changed with tax laws and times. Even today, there isn’t a single best choice, as every family’s financial picture has their own nuances. That being said, 529 savings plans often end up utilized as an important part of an education saving strategy.
A significant reason for this is that 529 savings plans are more flexible and more accessible than many clients believe. As we’re approaching the start of another school year, it seems like a good time to highlight the most common questions we get about 529 plans, with the answers of course!
QUESTION 1: IF MY STATE OFFERS A 529 PLAN, DO I HAVE TO CHOOSE THAT PLAN?
Not at all. While there can be some advantage when a state income tax is applicable, this is still just part of the picture. For the funds to be used for qualified education expenses, whether the plan is in-state or out of state doesn’t matter. Much more important are the investment choices and the overall costs associated with each plan.
QUESTION 2: DOESN’T MY CHILD/GRANDCHILD HAVE TO USE THE MONEY BY A CERTAIN AGE?
No. There is no age limit for 529 savings plans. This is one of the top misconceptions regarding 529’s, perhaps because people recall the older Coverdell Education Savings Accounts, which do require that funds be used by age 30 or given to another younger family member, to avoid taxes and penalties.
Furthermore, the types of college expenses which are “qualified” include tuition and fees, books and supplies, computers and internet access, room and board/rent, and special needs equipment. Up to $10,000 per year for K-12 tuition was also added as a qualified expense as part of the 2017 Tax Cuts and Jobs Act.
QUESTION 3: WHAT HAPPENS IF SOME OF THE FUNDS ARE NOT USED?
If the balance in a 529 plan is not needed to pay for the original beneficiary’s qualified expenses, the beneficiary can be changed to another family member or the funds can be distributed and taxed at the beneficiary’s rate. Taxes will only apply to the growth (earnings) in the account, not the original contributions. Additionally, there are several exemptions from the 10% tax penalty on non-qualified distributions. Among them are receipt of qualified scholarships, attendance at a U.S. military service academy, or receipt of education tax credits.
QUESTION 4: HOW MUCH CAN I CONTRIBUTE?
Unlike many other tax-advantaged savings accounts, such as IRAs or Roth IRAs, there is no income limit or earned income requirement in order to contribute to a 529 plan.
Contributions are considered gifts for tax purposes. Currently, that means up to $15,000 per individual would qualify for the annual exclusion. Furthermore, you could make a lump sum contribution up to $75,000 (or $150,000 if married) if you take the election on IRS Form 709 (Gift Tax Return) to spread out over five years.
QUESTION 5: WILL A 529 PLAN “MESS UP” FINANCIAL AID ELIGIBILITY?
Currently, a 529 plan owned by the parent will need to be reported on the FAFSA each year, but only up to 5.64% of the assets are counted. 529 plans owned by a grandparent or someone else are not counted on the FAFSA as an asset but 50% of distributions are treated as student income. Because the FAFSA looks at income from two years prior, a common strategy (assuming graduation in four years) is to delay distributions from grandparent-owed plans until after the second year of college. Some plans do allow for an ownership change but it’s very important to confirm beforehand if the plan will report the change as a taxable distribution.
For more information, download our free Education Funding Checklist.
Do you have any other questions about 529 savings plans or general financial planning? We’d love to hear from you!