When it comes to saving for college, the 529 plan remains hugely popular, with more than $ 352 billion in assets, by some estimates. In my previous article (When Choosing Funds for Your 529 College Plan, Don’t Make This Mistake), I looked at how to maximize the growth of your 529 plan. Many readers have agreed with me that the mutual fund options of Age-based placements in 529 plans are often too conservative.
Still, many parents had additional questions about how the 529 would work. After all, the plans are complicated and have very specific rules and regulations. In this article, I will summarize the answers to the most frequently asked questions about the 529. However, this list is not exhaustive and if you want to know more, join me on April 20 and 23 at 12 p.m. EST for a free webinar on college savings strategies.
Here is a selection of what you need to know about 529 plans:
What is a 529 plan? The name 529 comes from a section of the IRS tax code. Section 529 qualifying tuition programs are investment accounts administered by each state and intended to be used for qualifying education expenditures.
What are the tax advantages? Generally speaking, income from contributions to the 529 plan can increase without federal income tax, and withdrawals used to pay for eligible education expenses are also exempt from federal income tax. Contributions are in after-tax money; however, most states offer an income tax deduction for contributions, but this varies for each state.
Should I use my state plan? No, you do not need to be a resident of that state to use another state’s plan. However, there may be tax advantages to using your own state. It is best to speak with your accountant or financial advisor before opening an account.
What are “eligible” education expenses? Eligible education expenses include tuition, compulsory fees, textbooks, computers and software, required supplies, equipment, and accommodation and meals if enrolled at least part-time. Accommodation and meal costs may not exceed certain amounts, either the actual billed cost of living on campus or, if off campus, the applicable rate determined by the college or qualifying institution. Services with special needs for a recipient with special needs are also considered an eligible expense.
Should a 529 account be used for college? What about other schools, like a trade or a vocation? 529 assets can be used at any qualifying higher education institution. This includes four-year colleges, universities, two-year qualification programs, trade schools, and vocational schools. To be eligible as an eligible institution, a school must be eligible to participate in student financial assistance programs offered by the Department of Education.
Can 529 money be used for K-12 schools? A relatively new provision allows 529 account holders to withdraw up to $ 10,000 per year per student for private elementary or secondary education. Unlike college, this only applies to tuition fees, not textbooks, computers or other expenses or activities.
What if money is withdrawn for any other expense that is not considered “qualified”? Any income on an ineligible withdrawal is subject to a 10% federal penalty tax. In addition, income is subject to federal tax and, where applicable, state income tax.
Are there any exceptions to the 10% penalty? What if my child receives a scholarship? Withdrawals following the death of a beneficiary, disability or receipt of a grant (within the limit of the grant) will be not be subject to the 10% penalty. However, you will have to pay taxes on the winnings.
Who can open an account? Any natural person of legal age to open an account and who is a U.S. citizen or legal resident. In addition, US trusts, corporations, partnerships, and nonprofits can open an account.
Who is the owner? Usually, the parent is the owner. There can only be one owner, no co-ownership. However, there is an option for a successor owner if the owner of the account dies.
Who is the beneficiary? Usually this is the child, but it can be anyone, including yourself, and the beneficiary must be either a U.S. citizen or a legal resident of the United States.
Who can contribute to the account? Any person or entity can make contributions to the account for the benefit of a beneficiary at any time.
What are the contribution limits? Contributions to 529 education savings plans are considered gifts for tax purposes. In 2021, donations totaling up to $ 15,000 per person are eligible for the annual donation tax exemption. This means that if you and your spouse have three children, you can donate $ 90,000 without tax consequences, since each child can receive $ 15,000 in donations from you and $ 15,000 in donations from your spouse. Keep in mind that this also includes gifts other than 529 (like gifts to a life insurance trust), so be sure to take that into account.
Is there an aggregate limit to 529 plan accounts? Technically, there are overall limits at 529 plan account balances. But the limits can vary from state to state, typically from $ 235,000 to $ 529,000. Once a 529 plan’s balance reaches its limit, the plan will no longer accept new contributions. It’s worth mentioning that some plans will factor in balances from other 529 plans for an overall overall limit. For example, if the owner has more than one 529 for the same beneficiary, the plan can aggregate all of the plan’s balances to determine if the maximum limit has been reached.
What is the five-year election? You can “advance” your donations or contributions to a 529 plan and spread the donation over five years for donation tax purposes. For example, if you donate $ 75,000 in 2021, you can choose to use five years of donation in one year ($ 75,000 divided by the annual exclusion of $ 15,000). This is important for large properties. Any contribution of 529 above the annual exclusion amount is deducted from the lifetime donation exemption, which is currently $ 11.7 million per person in 2021 (Source: SavingforCollege.com). Staying under the annual $ 15,000 exclusion or using the five-year election will help preserve your lifetime donation exemption for other donations.
What are the tax consequences of contributing to a 529 plan? Except in special circumstances, contributions to a 529 plan are not considered part of the contributor’s estate for purposes of calculating estate tax.
Can you transfer money from other accounts to a 529? Tax-free rollovers from one 529 to another 529 with the same beneficiary are allowed once every 12 months.
Can you integrate UGMA or UTMA assets into a 529? Yes, transfers from a UTMA / UGMA are allowed, but restrictions apply. To transfer UTMA / UGMA accounts to a 529 plan, you may need to sell the UGMA / UTMA assets first. Generally speaking, UTMA / UGMA accounts do not allow a change of beneficiary, and as such, this restriction will apply to UTMA / UGMA assets transferred to a 529. It is best to consult a financial or tax advisor before proceeding. transfer UTMA / UGMA assets to a 529.
Can you change beneficiary? A 529 account holder can change beneficiary at any time. However, the new beneficiary must be a family member of the previous beneficiary to avoid being considered a withdrawal. If the account holder changes the beneficiary to a new beneficiary who is more than one generation younger than the previous beneficiary, the generation skip transfer tax may be triggered. For example, a parent who changes the beneficiary of their child to their grandchild is considered a generation jump transfer.
Can you change the investments in a 529 account? Currently, the IRS allows an account holder to change the mutual fund (s) only twice a year. There is currently no “aggregation rule” regarding investment changes, so the investment change limit of two per year is per account. For example, if an owner and beneficiary have 529 other accounts, each account will have its own limit of two changes per year.
What is the treatment of 529 for financial aid? 529 assets can affect a recipient’s ability to qualify for federal needs-based financial assistance. A 529 is a student asset if the student is considered an independent student for tax purposes or a parent asset if the student is a dependent student. A student is considered self-employed if, among other criteria, he is at least 24 years old, or married, or a graduate or professional student. As a general rule, if a student is considered “dependent” and the 529 is a parent’s asset, the more favorable the treatment of financial aid. A 529 should not affect eligibility for a merit-based scholarship.
As you can see, a 529 Education Savings Plan has many rules. But if you follow the rules, 529 is an unpretentious place to save for college and private school. There are several advantages, including the possibility of deferring income taxes, withdrawing income tax-free for eligible education expenses, as well as the possibility in some states to deduct – within certain limits – the contribution of state income tax. Most accounts also offer multiple investment choices, from autopilot programs, such as age-based options, to the ability to choose individual funds, all of which could help contributions grow and keep pace. future costs of colleges.
The 529 plan is also very flexible, with the ability to change beneficiaries without incurring a penalty (assuming it is another qualified beneficiary). For new parents, the low minimum contributions and the ability to invest automatically are attractive features. In addition, there are benefits for high income earners such as no income limitation to open an account, very high contribution rates and a contribution is a donation made for inheritance tax purposes if the tax planning is important.
Higher education is a way to improve the lives of many people, and the 529 Plan remains a great way to help you do that.