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Thoughts Before Funding an Education Savings Plan 529

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College costs have exceeded inflation. Looking at the past decade, the historic 10-year rate of increase has been around 5% per year, according to The College Board. Fortunately, there is a tax-efficient way to save for those growing college expenses: the 529 Education Savings Plan.

When it comes to saving for college, opening a regular savings / custody account for your child is an option, but you would miss out on the benefits of a plan. 529, such as tax-free growth in income if funds are used for qualifying university expenses. Deposits in a 529 plan of up to $ 15,000 per person per year ($ 30,000 for married couples filing jointly) will qualify for the annual gift tax exclusion (for 2021). You can also take $ 75,000 from your investment in a 529 plan ($ 150,000 if joint with your spouse) and use it for your gift tax exemption for five years, provided it there was no other donation to this child. This is something that is not possible for a regular savings / custody account for your child (you could only donate $ 30,000 jointly). By adding a large amount up front, you allow the lump sum to grow over a longer time horizon rather than making smaller contributions over time. Contributions to a 529 plan do not have to be reported on your federal income tax return.

Contributions to a 529 plan are not tax deductible (although some states do offer tax benefits), but income grows tax-free and is not taxed if used to pay for education . Another advantage over a conservative account is control; the designated beneficiary has no legal rights to the funds, so you can ensure that the money will be used for education.

On the positive side too, a 529 account held by someone other than the parent (such as a grandparent) is not considered an asset for financial aid purposes. Additionally, the value of a 529 account is removed from your taxable domain, but you retain full control of the account.

Research the underlying expenses of mutual funds and review the investment options available compared to other plans. Age-based models may be the easiest to manage, as the plan shifts to more conservative investments as the student approaches college age. You can choose any state plan no matter where you live, but if you live in a state that offers tax breaks for using your state plan, you’ll probably want to start there. For example, New York residents receive tax benefits for using their state plan. Keep in mind that you have the option of moving your 529 to another supplier, but only one rollover is allowed per 12 month period.

How much to contribute to a 529 plan depends on several assumptions, such as whether you expect your child to attend public college or private college, returns over the investment horizon, and future college inflation. . Funding goals vary widely depending on what you want to achieve and the assumptions involved – and of course, there’s no right answer.

If the beneficiary does not go to college, you can transfer the 529 plan to a future sibling or to another family member, such as a cousin or grandchild. If you don’t have any eligible family members, the worst-case scenario is that you have to pay taxes and a 10% income penalty to withdraw the money for other purposes. Withdrawals from a 529 plan that are not used for the beneficiary’s eligible education expenses are taxed and penalized (subject to a 10% federal penalty and taxed at the income tax rate of the person receiving the withdrawal). If the beneficiary obtains a scholarship, the penalty is waived.

If you have more than one child, it may be a good idea to fully fund the first plan for the older child, and if the funds are not used, they can be transferred to the next child. You probably want to avoid fully funding all plans in case a child doesn’t end up going to college, getting a scholarship, or starting a business. Some schools and trade schools / programs are not eligible for 529 funds (for example, if a grandchild wants to attend a specific theater or cooking school). You can find out if your school is eligible by using this link: https://www.savingforcollege.com/eligible_institutions/.

Avoid overfunding the 529 if possible, as “eligible tuition fees” do not cover all college-related expenses. Eligible expenses include:

  • Tuition and fees.
  • Room and board on campus.
  • Books and supplies.
  • Computers and related equipment.

However, many college-related costs are not considered eligible expenses. These costs can easily add up, so it may be a good idea to save outside of a 529 plan to cover them. Funds from a 529 plan cannot be used for:

  • The purchase of a car, fuel costs or public transport costs to and from school.
  • No insurance (car, health, etc.) can be paid with 529 funds either.
  • If your child is a member of a school club or involved in a sporting activity, all associated fees and costs are also not eligible.
  • It may seem intuitive that, if you have a student loan, you can use funds from a 529 to pay off the balance, but that is also not allowed.

If your child plans to live off campus, in accommodation that is not owned or operated by the college, you cannot deduct expenses in excess of the school’s estimates for accommodation and food for the school. attendance. It’s important to confirm room and board costs with the school’s financial aid office in advance, so you know what to expect. Also, keep in mind that for room and board to be eligible, your child must be enrolled part-time or longer.

Finally, if your child is studying abroad, check with the school to find out if the study abroad program is eligible for 529 funds.

If you inadvertently use funds for the wrong expenses, you will end up being taxed on the income and incur a 10% penalty on that amount. While the 529 plan accounting tends to run on the honor system because you have to track your own expenses, using funds for the wrong items could have consequences in the event of an IRS audit.

Paying for college is a big expense for many families. 529 plans are a tax-efficient way to save money for college, but they come with complex rules and restrictions. Therefore, understanding how these accounts work before you invest could help you avoid unforeseen tax penalties in the future.

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