Saving with a 529 College Plan

As the excitement builds for National 529 Day later this month on 5/29 [clever, eh?], it seems only appropriate to help our clients and readers to gain a better understanding of this type of college savings account.

First, and foremost, you should know it’s generally unwise to fund your child/ren’s college with a 529 – as the sole account to meet college expenses. Depending upon a family’s situation, there are other types of college savings accounts that can meet your objectives or work in concert with a 529 account to pay for college. This brief disclaimer aside, let’s learn more about a 529.

What is a 529 Plan?

A 529 plan, also referred to as a Qualified Tuition Program, is an investment account that receives preferential tax treatment when the savings are used to pay for a student’s qualified education expenses.

529 Plans originated in 1996 and have seen many enhancements over the years to make them a more attractive option to help families save for their child’s education. There currently are 102 different Plans available¹, and each of the 50 states (and DC) offers at least one Plan. But investors are not required to select a Plan offered in the state in which they reside.

Who may contribute to a 529 Plan?

Anyone may contribute to a 529 Plan account on behalf of any student (or future student). Contributors may be parents, stepparents, spouses, grandparents, aunts/uncles, and friends. The contributor who establishes a 529 is known as the owner, or “Participant” of the 529 account.

The student for whom the 529 account was opened is regarded as the “Beneficiary”. The Beneficiary of a 529 Plan may be changed at any time from one student to another. There is no age requirement for the Beneficiary, thus a 529 Plan may be established for adults who intend to use the contributed funds for qualified education expenses. Accordingly, an adult may establish a 529 Plan for himself/herself and would be considered both the Participant and Beneficiary.

How does one contribute to a 529 Plan?

Contributions to a 529 Plan are treated as a gift and qualify for the annual gift exclusion limitation per beneficiary of $18,000, or $36,000 for married couples (2024 figures). Alternatively, one may choose to contribute a combined sum of $90,000 ($180,000 for married couples), effectively bunching the next 5 years’ worth of contributions into one year up front. All contributions must be made with after-tax dollars.

Each state also has an aggregate contribution limit for all years to 529 Plans which ranges between $235,000 and $596,925¹.

What happens to contributions in a 529 Account?

Contributions in a 529 Account may be invested into Mutual Funds, Exchange-Traded Funds (ETFs), or potentially a guaranteed interest investment. Participants are discouraged from making frequent investment changes in a 529 Plan; the IRS only permits a maximum of two exchanges per calendar year from one investment option to another in an account.

What is the Tax Treatment of a 529 Plan?

Annual contributions to a 529 are not tax deductible at the federal level, but possibly may qualify for a state tax benefit. Over 30 states (and DC) offer a state income tax deduction or credit for contributions made to a 529 Plan¹.

Contributions to a 529 Plan grow on a tax-deferred basis and can be withdrawn tax-free if the distributions are used to pay for qualified education expenses. Distributions taken from a 529 Plan are allocated between principal and earnings on a pro-rata basis, which means every withdrawal includes both an earnings portion and a principal portion.

If distributions from a 529 Plan are not used to pay for qualified expenses, the earnings portion that was withdrawn is treated as ordinary income for state/federal income taxation, plus is subjected to a 10% federal income tax penalty; the principal portion is neither taxed nor penalized.

What are some of the expenses that a 529 Plan can cover?

A 529 Plan can be used to pay for K-12 tuition, college, apprenticeship programs, and a portion of student loan repayments. Here are some of the finer points of each:

K-12 Tuition

The Tax Cuts and Jobs Act of 2017 offered a provision that went into effect January 1, 2018, enabling distributions from a 529 account up to $10,000 per year to be applied toward Tuition Expenses as a public, private, or religious school – for kindergarten through grade 12. A few states are not compliant with this, thus 529 withdrawals in these states could trigger some state tax consequences.

College

Distributions from a 529 account may be used to pay for certain expenses at any college, university, or vocational school that is eligible to participate in a student aid program administered by the Department of Education. These eligible college expenses are known as Qualified Higher Education Expenses, or QHEEs. These include:

• Tuition
• Fees
• Books
• Supplies & Equipment (required for participation in class)
• Room & Board – a student must be enrolled at least half-time to be eligible
• A Computer (and/or Tablet), Peripheral Equipment, Computer Software, Internet Access Charges
• Special Needs Services & Equipment for the disabled
• Other Special Situations for penalty-free withdrawals
  • Scholarship & Grants – distributions up to the amount of a scholarship are not subject to the 10% penalty tax, although the earnings portion would still be subject to income tax.
  • Veteran’s assistance
  • Death
  • Disability
  • Attendance at a U.S. Military Academy
  • Study Abroad Programs – doesn’t include the cost of travel

Apprenticeship Program

Distributions from a 529 may be used to pay for certain expenses associated with an apprenticeship program registered and certified with the Secretary of Labor. These expenses include required fees, books, supplies and equipment.

Student Loan Repayment

This provision was added in December 2019 in the SECURE Act (Setting Every Community Up for Retirement Enhancement Act). It established a lifetime limit of $10,000 that could be withdrawn from a 529 Plan without any penalties or tax consequences to repay the student’s loans – including both federal and most private loans. Such an opportunity is available for each of the student’s siblings additionally, $10,000 can be withdrawn with no tax consequences to repay each of their student loans.

What are some of the expenses that a 529 Plan can NOT cover?

College Application and Testing Fees

A 529 plan will not cover any costs associated admissions or testing.

Extracurricular Activity Fees

Mandatory fees for extracurricular activities are covered, but fees for optional extracurricular activities are not.

Transportation and Travel Costs

A 529 plan will not cover costs associated with transportation to and from campus, such as airfare or gas.

Health Insurance

A 529 plan will not even cover health insurance policies offered by a school.

What if we have leftover funds in our 529?

This is a common concern among parents who may overfund a 529 account inadvertently. As stated earlier, parents can change the beneficiary from one student to another; this may be a plausible solution if there is another sibling next in line for college. But what if 529 funds remain after the final student has completed college?

An enhancement was made by Congress in a 2022 bill addressing this concern, although details remain to be sorted out with this legislation. This statute permits parents to rollover 529 assets, up to a limit, to a Roth account for the named beneficiary. If you would like to learn more about this rollover opportunity, check out this recent article.

The Bottom Line

A 529 account may offer an excellent solution to help meet your family’s college funding goals. Whether you’ve already established 529 plans for your children or plan to in the future, contact Signature Wealth Management Group to help you craft the best planning solution for your family!

 

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Sources/Info:

1  CollegeSavings.org – 529 Search & Comparison

This material is for informational or educational purposes only. Investing involves risk including the potential loss of principal. No investment strategy can guarantee a profit or protect against loss in periods of declining values. Diversification does not guarantee profit nor is it guaranteed to protect assets. Opinions expressed are subject to change without notice and are not intended as investment advice or to predict future performance. Past performance does not guarantee future results. Consult your financial professional before making any investment decision and always consult an attorney or tax professional regarding your specific legal or tax situation.