Josh Frankel, CFP®
Executive Vice President, Portfolio and Wealth Management
With the COVID-19 pandemic creating slight confusion on what day it is, much less what month we are in, some of us may not have seen National 529 Day on our calendars. Newsweek and CNBC have highlighted the day and there are even a handful of states offering financial promotions to encourage savings. Here is what you need to know about 529 college savings plans that give cause to celebrate.
What is a 529 Plan?
A 529 college savings plan is a tax-advantaged account designed to encourage savings for a beneficiary’s education. Money saved in a 529 plan can be used tax-free for a wide range of college expenses, K-12 tuition, certain apprenticeship costs and even student loan repayments. In addition, unlike a custodial account often referred to as Uniform Transfers to Minors Act (UTMA), the account owner of a 529 plan maintains control of the account until the money is withdrawn. There are also estate planning benefits to consider.
Tax Advantages
There are federal and state tax benefits to fund a 529 plan. Although contributions are not deductible at the federal level, earnings in a 529 plan grow tax-free from federal taxes and distributions will not be taxed that are being used for qualified college expenses.
Several states also offer a full or partial tax deduction or credit for 529 plan contributions. Each state has its own rules and regulations regarding the type of tax benefit and the extent of the deduction or credit. Effective January 1, 2020, Oregon offers a state income tax credit up to $150 for single filers and $300 for joint filers, subject to income limitations. At both the federal and state level, there are no income limits to fund a 529 and earnings are fully exempt from taxes if used for qualified expenses.
With the potential for state income tax deductions for contributions, tax-free growth and tax-free withdrawals, 529 plans are often referred to as triple tax-advantaged.
Qualified Expenses
Money within a 529 plan can be used for a variety of qualified expenses without a penalty or taxes. If money from a 529 plan is used for any other reason, it could come at a steep cost, which includes a 10 percent penalty and the payment of federal and state income taxes on the embedded gains. In addition, there is a distinct possibility of needing to pay back income tax deductions claimed on the contributions.
Fortunately, most expenses related to higher education are in fact qualified. Some of the most common qualified expenses as defined by the IRS include:
Tuition and fees at eligible institutions
Books and school supplies
Technology such as computers, printers and even internet service
Certain room and board expenses
Special need resources
In addition, tax-free withdrawals may also include up to $10,000 in tuition expenses for private, public or religious elementary and secondary schools. A handful of states, including Oregon and California, do not follow the federal law that allows 529 plan withdrawals for K-12 tuition expenses. It is highly recommended that a 529 account owner consult with a CPA prior to using funds for K-12. In 2019, it was announced that student loan payments up to $10,000 in aggregate and costs of apprenticeship programs were added as qualified education expenses.
A few expenses that would not qualify include airline tickets and travel costs, auto payments, gym memberships, clothing and entertainment.
Funding and Control
For 2020, an individual can contribute up to $15,000 annually ($30,000 for married couples) without gift-tax implications. Under a special election, an individual can contribute up to $75,000 ($150,000 for married couples) at one time by accelerating five years’ worth of “annual gifts” as contributions in one year. In addition, the individual or couple making the gift can even maintain control of the funds. These features make the 529 plan an attractive estate planning tool.
Keep in mind that within the five-year period, the contributor will not be able to make additional gifts to the beneficiary without triggering the federal gift tax or using the lifetime gift tax exemption. As always, it is recommended to consult with tax and estate advisors for more information regarding the gift and estate tax consequences of a 529 plan.
Other Considerations
There are several other considerations when funding a 529 plan that may require a broader financial planning discussion, such as
How much is needed to pay for college for children and grandchildren?
What happens with excess funds remaining in 529 when beneficiary completes college?
What is the best strategy for asset allocation based on the time horizon for needing the education funds?
How do tuition refunds and financial aid affect planning?
What are the parameters for changing beneficiaries?
It is important to note that if during the COVID-19 pandemic, you or your beneficiary were reimbursed for tuition due to cancelled classes, that the money needs to be redeposited into the 529 plan to avoid penalties and tax implications.
Clearly, there are many things to consider when incorporating 529 college savings plan in your financial planning and your Ferguson Wellman and West Bearing team is available to help. Don’t let those nuances prevent you from celebrating National 529 Day.
Important Disclosures: Ferguson Wellman and West Bearing do not provide tax or legal advice. This material has been prepared for general educational and informational purposes only and not as a substitute for qualified counsel. You should consult qualified professionals to understand how this information may, or may not, apply specifically to you.