by Evan Shorten
529 College Savings Plans, or simply 529 plans, are state-sponsored savings plans used to save for college or other higher education. Typically, 529 plans are used by families to save for their children’s, or grandchildren’s, higher education needs. However, any adult may establish a 529 plan for a beneficiary of their choosing; the account owner and beneficiary do not need to be related. In addition, any adult, not just the account owner, may gift funds to a 529 plan. This makes 529 plans ideal for gifts from family and friends. Read on to learn more about 529 college savings plans.
529 plans provide many tax benefits. One of the most advantageous is tax-free growth on the funds gifted to the plan. Those gifts will not incur capital gains or income tax while in the plan, thus allowing for greater growth potential over long periods of time.
When it is time to use the funds held in a 529 plan, the distributions are taken tax-free. It is important to note, that only withdrawals for qualified education expenses receive this tax benefit. Qualified education expenses include tuition and fees, room and board (on-campus, off-campus, fraternity and sorority housing), books, supplies, technology equipment and software, tutoring, transportation, etc. For a complete list of qualified education expenses please visit, www.irs.gov/Individuals/Qualified-Ed-Expenses. Please note, non-qualified, and/or excess withdrawals beyond education costs, will be subject to a 10% penalty on earnings, plus penalties on any gifts that received tax deductions.
Income Tax Deduction
Depending on your state of residence, some states may provide you an income deduction or credit for gifts made to a 529 plan. Please note the following states do not: California, Delaware, Hawaii, Kentucky, Massachusetts, Minnesota, New Hampshire, New Jersey, and Tennessee.
Contribution Limits and Gift Tax Flexibility
For 2016, gifts to 529 plans have a maximum limit of $14,000 per year, per adult, and are treated as gifts to the beneficiary. Additionally, 529 plans provide flexibility when planning for gift tax limitations. 529 plans allow you to gift up to a 5-year maximum, upfront in the current year, without triggering a gift tax. To clarify, you could gift up to $70,000 at once without triggering a gift tax. The IRS will consider the gift as having been made over a 5-year span. Furthermore, you could gift $14,000 in 2016 and $70,000 (5 years upfront) in 2017 for a total of $84,000. Please note that no other gifts can be made to the beneficiary, without incurring a gift tax, during the five year period when the original $70,000 was gifted. As an added bonus, there is no limit to the number of people who may contribute to a single 529 plan. Therefore, your spouse could double your gift if your estate is large enough. The only item to consider is that some plans establish life-time limits on how much you may gift to a 529 plan. For example, some plans will only allow a maximum of $310,000 in total gifts, regardless of the number of individuals giving to the beneficiary.
One of the most liked characteristics of 529 plans is that you, the account owner, retain control of the account, regardless of the age of the beneficiary. This keeps the funds from being misused or misspent on something other than higher education; a common worry amongst parents and grandparents who gift their children or grandchildren money for school.
529 plans provide flexibility in assigning a beneficiary. If for some reason your assigned beneficiary chooses not to pursue higher education, you as the account owner, have the ability to assign a different beneficiary. If your assigned beneficiary were to receive a considerable amount in financial aid or scholarship funding, you have the ability to change the beneficiary to someone with a greater need for educational funding. Also, if the 529 balance were to grow beyond the financial need of your assigned beneficiary, you have the flexibility to establish and fund other 529 plans using the original one. This provides a great benefit for larger families where excess funds can be transferred to other children or the children of relatives.
Use any State’s Plan
529 plans are not all created equal. Different plans have different fees, investment choices, life-time gift limits, etc. Fortunately, you have the freedom to choose any state’s 529 plan, whether you are a resident of that state or not. If your state does not provide a tax benefit for using their plan, you should shop around and search for a low cost plan with quality investment options. Do not immediately default to your state’s 529 plan without having done due diligence to ensure it is the best plan for your needs.
A Few Things to Keep in Mind
Due to their intended purpose, 529 plans do not allow excessive trading; plans can only be rebalanced twice per calendar year.
Assets held within 529 plans must be reported on the Free Application for Federal Student Aid (FAFSA) and are taken into consideration when determining financial aid packages. How FAFSA treats 529 assets is dependent on who owns the account. If the account owner is a parent of the beneficiary, the 529 plan is treated as assets belonging to the parent. If the 529 account owner is someone other than a parent, such as a grandparent, the distributions made to the beneficiary will be treated as income to the beneficiary on the FAFSA application.
Paragon Financial Partners, Inc. is a Registered SEC Investment Advisor. This write-up is for informational purposes only and should not be considered as a solicitation or offer to purchase or sell any securities. The financial strategies and guidelines discussed herein may not be appropriate for everyone as each individual circumstance is unique. Please review all tax information with your tax professional. Please review all legal information with your legal professional.
To learn more about Evan Shorten, view his Paladin Registry profile.
Other posts from Evan Shorten
Your 60’s is the home stretch and the last decade for you to dot your “i’s” and cross...
Your 50’s is a time when you see the fruits of your labor come to fruition. This is...
As you enter into your 40’s you might feel a sense of financial stability as your career and...