May 29 is National 529 College Savings Plan Day! Do you know what a 529 plan is? Do you know how to use it? Let me explain.
What is it?529 College Plans were initially created to help families save money for higher education expenses for children, grandchildren, or others. They are named after Section 529 of the Internal Revenue Code (IRC) which created these types of savings plans in 1996. While many people use these plans for that purpose, there are other considerations that can make them fantastic vehicles for avoiding different types of taxes.
Who can open one?529 Plans are owned individually by an adult person, meaning a person of majority age, but they name a beneficiary who can be a minor or adult. Any adult may open a 529 Plan for any named beneficiary—you do not have to be the parent or grandparent of the person named.
What are the tax benefits?When you fund a plan like this there is no federal tax deduction. Some states have enacted tax parity which allow limited deductions from state income taxes for contributions, while other states offer a state income tax deduction only for specific plans. Every state has unique rules and contribution limits, and you can review them at www.savingforcollege.com. In addition to a possible full or partial state income tax deduction, 529 College Savings Plans offer other benefits as well:
Revocable giftsUnlike custodial accounts under the Uniform Gifts to Minors Act (UGMA) or the Uniform Transfers to Minors Act (UTMA), the account balance in a 529 Plan does not belong to the beneficiary; it still belongs to the owner who opened it. The owner has a lot of flexibility in the event they need the money for other purposes or if the beneficiary gets a scholarship or elects not to attend school. It is also permissible to adjust the beneficiary assignment once per year, to maintain flexibility under changing circumstances. If the funds aren’t needed for college by a specific generation, they can be held for the next generation with no gift or generation-skipping taxes due. Anyone can open a 529 for any beneficiary, any time, for as many people as you choose.
Savings on estate taxesEven though the federal estate tax rules have very strict guidelines requiring completed gifts to avoid taxation, the 529 Plan is an exception to that rule. Balances are considered to be outside of the owner’s taxable estate when he or she dies. For wealthy families, this provision can save estate and inheritance taxes for multiple generations.
Income tax-free growth and withdrawalsThere are no capital gains or ordinary income taxes assessed on money in a 529 Plan. When the money is withdrawn, as long as it is used for a qualified purpose, there are no taxes due whatsoever. After-tax money goes in and grows just like in the Roth IRA, and if used properly the account will never be taxed again. A full list of qualifying expenses and eligible institutions can be found at www.savingforcollege.com, and generally qualifying expenses include costs of attendance for undergraduate or graduate educations, with no restrictions as to the state in which a beneficiary lives or attends school. Because of tax reforms, effective January 1, 2018, plans now allow up to $10,000 per year per beneficiary to be used towards K-12 private school education. Note also that the SECURE Act changed the 529 Plans’ list of qualified purposes to include certain apprenticeship programs, and to allow up to $10,000 to be used (only once, not annually) to reduce student loan debt for the named beneficiary.
High contribution limitsContribution limits for 529 Plans are the same as the federal annual gift tax exclusion, which is $15,000 per donor, per donee, per year as of 2020. This means a married couple can put up to $30,000 away each year for each child or grandchild without creating a taxable gift or requiring a gift tax return to be filed. In addition, parents or grandparents or other adults are allowed to fund up to five years at once up front – so you can put $75,000 per adult, per beneficiary, into the accounts. To maximize the benefits of income tax deferral, estate tax exclusion, and tax-free growth, for example, grandparents can move $150,000 out of their estate into accounts for their grandchildren that will never be taxed again. And if the idea of giving away those funds creates any fear of running out of money during the donor’s lifetime, remember that the gifts aren’t irrevocable and the assets can be withdrawn by the donors, if necessary.
Limited impact on financial aidFrom a tax perspective, a 529 College Savings Plan is a panacea as long as it’s used for its intended purpose. With the spiraling costs of education and so much attention being paid to financial aid and student loans, it is important to note that 529s do not adversely impact financial aid for the beneficiary in the same way that accounts in their own name would, which makes them even more attractive. For college funding, it is especially important to avoid UTMA or UGMA custodial accounts (which count against financial aid dollar-for-dollar) and to use 529 Plans instead.
The downsideIf the money is not used for qualified expenses, ordinary income taxes plus 10% penalties are due on any gains in the account (but not on a contributed basis).
The lesson:If you have a child, grandchild, niece, nephew, or neighbor that you want to support in his or her education, a 529 plan is a good way to do so in a tax-efficient way. Understanding the uses and benefits of these plans is important in making the decision to invest in one.
The opinions expressed in this commentary are those of the author and may not necessarily reflect those held by Kestra Investment Services, LLC or Kestra Advisory Services, LLC. This is for general information only and is not intended to provide specific investment advice or recommendations for any individual. It is suggested that you consult your financial professional, attorney, or tax advisor with regards to your individual situation. Comments concerning the past performance are not intended to be forward looking and should not be viewed as an indication of future results. Securities offered through Kestra Investment Services, LLC (Kestra IS), member FINRA/SIPC. Investment advisory services offered through Kestra Advisory Services, LLC (Kestra AS), an affiliate of Kestra IS. Brotman Financial Group, Inc. and BFG Financial Advisors are not affiliated with Kestra IS or Kestra AS. Investor Disclosures: https://bit.ly/KF-Disclosures For more information about 529 Savings Plans, talk to your financial or tax professional, or visit https://www.finra.org/investors/alerts/college-savings-plans-school-yourself-you-invest or http://www.msrb.org/msrb1/pdfs/MSRB-529-Investor-Guide.pdf
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