As their kids return to school, planning for the eventual college attendance is on the minds of many parents. Even for parents of young children, college costs are a significant concern, and for good reason. Four-year public university tuition has risen 180% since the 1980s, and even though this rate increase has slowed slightly during the pandemic, many families anticipate they’ll struggle to afford college when the time comes.
While there are some government programs that help reduce the cost of a college degree, many families will need to dip into their savings to send their kids to college. Fortunately, if parents start saving for college when their children are still young, they may be able to fund (or mostly fund) their kids’ college careers. Though there are many ways to save for college, 529 plans are an option that must be given consideration.
Basics of 529 plans
529 plans are state-sponsored, tax-advantaged investment accounts that are earmarked for college. Even though 529 plan contributions aren’t deductible, the account will grow tax-free, and that growth will remain tax-free as long as you use those funds for qualified education expenses.
Because 529 plans are administered by state governments, fees and administrative requirements vary, but in general, here’s what you can expect if you open a 529 plan.
The IRS doesn’t limit how much you can contribute to a 529 plan, but because contributions are considered gifts, most taxpayers self-restrict their annual contributions to $16,000 so as not to eat into the lifetime gift allowance of $12.06 million. If you contribute more than $16,000 per year to any single 529 plan, you must report that contribution as a taxable gift and file a gift tax return.
529 plans benefit one named individual, which means that parents with multiple children who are close in age often open one account for each of their children.
Even though 529 plans can have only one named beneficiary, you can change the beneficiary if you need to. For example, if your first child is awarded college scholarships and won’t need the funds in their account, you can change the named beneficiary of their 529 account to one of your other children, a child of a close friend or family member, or even yourself or your spouse if either of you plan to go back to school.
Who can contribute
When you open a 529 plan, you are the owner of that plan, which means that you and your spouse are the only ones who can contribute to it. If your child’s grandparents (or aunts, uncles, cousins, etc.) want to help pay for your child’s college education, they can do so by opening their own 529 account and naming your child as the beneficiary. Your child can be the named beneficiary in any number of 529 plans.
Qualified education expenses include:
- Tuition and related fees
- Computers and related equipment
- Required books, supplies and equipment
- Room and board
These expenses can come from a four-year university (public or private), community colleges, trade schools and graduate programs.
Other qualified uses
When Congress passed the Tax Cuts and Jobs Act (TCJA) in December 2017 and the SECURE Act in December 2019, it expanded the use of 529 plans. No longer are 529 plans limited to college education costs. 529 plans can now be used to help pay for:
- Elementary and secondary education
You can direct up to $10,000 each year from your 529 plan to pay for primary and secondary tuition expenses. This includes public, private and religious schools but doesn’t include most homeschooling. Only tuition is covered, which means that you cannot use your 529 plan to pay for your elementary, middle school or high school student’s computer, books or field trips.
- Registered apprenticeship programs
529 plans can pay for tuition, fees, books, supplies and equipment for apprenticeships that are registered and certified with the US Secretary of Labor.
Beneficiaries can apply up to $10,000 in their lifetime from any 529 plan to pay down student loans after graduation. An additional $10,000 can be used to pay off the student loans of one of their siblings.
A lesser-known rule related to 529 plans is “superfunding,” whereby the owner of the 529 plan can contribute up to five years of the annual gift tax exclusion amount ($16,000 in 2022) and the IRS would consider it favorably as if the gift was made over five years. This helps accelerate earlier contributions into the plan, allowing more time for the funds to grow tax-free.
You can open a 529 plan in any state, so take time to review each state’s plan. There are a few things to consider when making your selection:
Although you will not receive a federal deduction for 529 plan contributions, you may receive a state tax deduction (or credit). In most cases, you must contribute to your home state’s plan to receive the benefit. If you contribute to a 529 located in another state, you’ll receive all the federal benefits described above, but you may not be eligible for a state tax deduction.
While there’s no federal contribution limit, some states have set their own aggregate contribution limit for 529 plans administrated within their jurisdiction; this should be reviewed carefully.
You should check with your child’s school to see if being the beneficiary of a 529 plan will affect their ability to qualify for student loans. Some states consider 529 plans to be assets of the beneficiary when determining eligibility for grants and financial aid.
If you move to a new state, you may be able to transfer your existing 529 plan into your new state’s 529 plan. However, your state may treat that rollover as a non-qualified distribution, which could cause that rollover to be taxed as income.
Each plan offers a different set of investment options. Select the plan that offers investments you are excited about.
Look at the plan’s minimum contribution requirements, management fees and investment fees. You may also owe fees to a financial advisor if your plan is managed through a broker-dealer.
Investing in your child’s future
As with any investment, opening a 529 plan isn’t completely risk free, but it is a powerful method to invest in your child’s future. Contact your Mazars advisor if you want to discuss your children’s college funding options. We can help you select a plan that works with your tax position and financial goals.
Published on September 2022