By: Ashley Hampton, MPA, Keisha Price, CPA, MST, and Febby Sugianto, MBA
A 529 plan is a tax-advantaged educational savings plan that, if approached thoughtfully, can help reduce the overall burden of a family’s educational expenses. As with most savings vehicles, starting early and contributing consistently is a major factor of overall accumulation of value; however, there are other things to consider to maximize to benefits of 529 plans. Today, we will focus on six keys to unlocking the power of 529 plans.
If you are not familiar with 529 plans, this prior blog may provide helpful background.
Key #1 – It’s Never Too Early or Too Late to Open a 529 Plan Savings Account
Although 529 plans require the beneficiary to have a valid Social Security Number (SSN), expectant parents can get a head start by opening a 529 plan where another qualified family member (parents and siblings, among others) is listed as the initial beneficiary. Once the child is born and an is SSN issued, the 529 plan beneficiary can be changed to the infant (limited to one beneficiary change within a 12-month period). It is easy to misstep and cause gift or generation-skipping transfer tax issues with this strategy due to some of the more nuanced rules, so be sure to consult a tax advisor.
Scholarly adults can also benefit from a 529 plan account post-undergrad as the funds may be used for graduate, professional and even trade school education.
Key #2 – Superfunding is Super
Like retirement plans, the earlier you can fund a 529 plan, the better. Since the funds grow tax free, assuming distributions are used for qualified expenses, the power of compounding in a 529 plan is further compounded. In a nutshell, there is a provision that allows individuals to make five years of annual gift tax exclusions at one time to fund a 529 plan. This means, instead of a $15,000 per year contribution (the current annual gift tax exclusion) a contribution of $75,000 ($15,000 x 5) can be made at one time, while still qualifying for the annual gift tax exclusion. This strategy will require gift tax returns to be filed, so talk to a tax advisor to ensure everything is documented correctly.
Assuming parents have the means, a family could fund a 529 plan with $150,000 ($75,000 per parent) at one time using this strategy—ideally early in the life of the beneficiary. Eighteen or so years of tax-free compounding on $150,000 should cover at least one year of tuition at a private university in 2039, we hope.
Key #3 – It Takes a Village, and the Village Could Get a State Tax Deduction
Education savers need not worry. 529 plans allow for contributions from any source including, but not limited to, parents, grandparents, aunts, uncles, and godparents.
“Account Owners” can claim state income tax deductions for beneficiaries no matter their relation, where available. More than 30 states and the District of Columbia offer the account owner an income tax deduction for contributions to 529 plans based in their state. Arizona, Arkansas, Kansas, Minnesota, Missouri, Montana, and Pennsylvania allow for income tax deductions for contributions made to any 529 plan regardless of the account owner’s residency. Unfortunately, California, Delaware, Hawaii, Kentucky, Maine, New Jersey, and North Carolina do not offer any state income tax benefit for 529 plan contributions.
Key #4 – Scholarship Switcheroo
If a 529 plan beneficiary receives a scholarship, an amount equal to the award can be withdrawn from the plan and used for non-education-related (non-qualified) expenses without being subject to the ten-percent (10%) penalty. However, tax must be paid on the investment earnings generated from the original contributions. It is important to consider the growth opportunity cost when taking non-qualified distributions from a 529 plan.
Key #5 – 529 Plans and K-12 Educational Expenses
As we navigate the trials of education during the COVID-19 pandemic, virtual learning has taken center stage. Did you know that you can use up to $10,000 of 529 plan funds for K-12 tuition and certain qualified expenditures each year for the beneficiary, even if they are not physically in school?
Keep in mind: home schooling and virtual learning are two different things. 529 plan funds cannot be used for traditional home schooling. However, if your child’s school has moved to a virtual learning environment, 529 plan funds can be used to pay for tuition and expenses for laptops, printers and even enhanced internet connections, up to $10,000 per year.
Speaking of COVID-19 and its impact with 529 plans, check out our prior blog about the impact of tuition refunds on 529 distributions.
Key #6 – Thinking Beyond Traditional Four-Year College
529 plan funds are not limited to private and state colleges and university expenditures. Funds can be used to support learning at vocational and trade institutes such as Cosmetology, Auto Tech, Nurse’s Assisting, Dental Assisting, and other organizations deemed an eligible education institute. Eligible education institutes include those that are eligible for the Department of Education student aid by the U.S. Department of Education (Title IV Federal Student Aid).
529 plans are an effective instrument in a family’s toolbox for educational savings. With the six keys listed above, families can unlock some of the more powerful aspects of these tax-advantaged savings vehicles. Call on us to discuss how to maximize 529 plans in your family’s education savings plan.