While proposals regarding college costs and student debt are bandied about, and campuses struggle to find the best responses to the Corona Virus pandemic, we can clearly say two things regarding higher education: it is a significant expense that is a major planning issue for many households, and that the landscape is changing at an ever-quickening pace. Amidst this combination of high cost and complexity, 529 plans stand as one of the primary resources for planning and funding. In this context, a general understanding of the related rules and potential benefits of these vehicles can help families make prudent choices regarding their educational goals.
Here are five things you should know about 529 plans.
Types
As a starting point, distinctions should be made between the two types of 529 plans. Prepaid Tuition plans, available in a limited number of states and through the Private College 529 Plan™, allow investors to purchase either a contract for a given number of future semesters at current rates, or fractional units which are redeemable in the future based on average tuition rates at a target number of schools. Essentially, they allow you to lock in future college costs at today’s prices. While they do provide advantages, their flexibility can be somewhat limited, in terms of investment options, eligibility for participation, and the schools a beneficiary may attend. These plans are oriented toward schools within the state of residence, and while refunds or transfers may be available if the student opts to attend elsewhere, penalties or reductions may apply, depending on the particular plan.
More common, and more beneficial in most cases, are 529 College Savings Plans, which allow contributions to be invested for growth in advance of the expected educational cost, and then withdrawn to cover those costs at the appropriate time. Offered in all fifty states and the District of Columbia, investment options and costs can vary depending upon whether the plan is purchased directly, through a broker, or through a firm designated as a Registered Investment Advisor (RIA).
Benefits
Monies held in 529 plans can grow tax free, and later be withdrawn tax free if used for qualified educational expenses. The tax savings on compounding growth over many years can be significant. Additionally, many states offer deductions for contributions made into the plan. Rules regarding annual deduction limitations, carryforward of excess contributions, and coordination with Federal deduction status can vary by filing status, account ownership, and state.
In addition, some state plans may offer other incentives, such as a matching contribution, other financial aid assistance, or creditor protection.
Uses
529 plans can be used to cover qualified education expenses without taxes or penalties. For prepaid tuition plans, this is limited to tuition and fees. With College Savings plans, however, a wider range of expenses, including room, board, and supplies are eligible. Notably, 529 College Savings Plan monies, even if held in the plan of a particular state, can be used to pay qualified costs at any accredited educational institution in the country, so the student is not limited to schools within the account owner’s state of residence.
Additionally, College Savings Plans might also be used for pre-college private school tuition up to $10,000 per year, to pay down student loan debt up to $10,000 per lifetime on student or parental education loans, and in some cases for vocational training.
Coordination
Where financial aid may be a possibility, the strategy of saving through 529 plans should be coordinated with a knowledge of financial aid rules. The amount of a financial aid award can be influenced by who owns the 529 account, and the timing of withdrawals made from a particular 529 account. Strategizing around those issues can come into play when, for example, parents and grandparents each establish separate 529 accounts for the same beneficiary, a relatively common scenario.
More broadly, the choice to contribute into a 529 Plan should be made in the context of the various resources and goals of the parties involved. An appropriate balance should be sought between college funding and retirement planning, for example.
Succession
What if my child does not end up going to college? Or wins an academic scholarship? 529 Plans allow the grantor who is the account owner to name beneficiaries on the account, and to change beneficiaries if new circumstances arise. Switching to a younger sibling would be a common example. In addition, when opening the account, the grantor can name a successor owner. That person will have discretion over the account upon the original owner’s death, and the account will pass free of probate.
In the realm of transfer taxes, contributions into a 529 plan qualify as gifts, so annual contributions of $15,000 or less are excluded from gift tax. Going further, 529 plans permit five-year gift tax averaging, under which an individual can treat one larger contribution as if it were made over a five-year period for gift tax purposes. In practical terms, this means an individual can contribute one gift of up to $75,000, and a married couple twice that amount, with no gift tax consequences. A gift tax form, reflecting gift splitting in the case of the couple, does need to be filed when employing this strategy, which is very useful for those with estate tax concerns. Finally, under current law, an owner can transfer ownership of the account, during his or her lifetime, to a new owner without any estate or gift tax ramifications. While there are maximum balance limits after which no further contributions are permitted (amounts vary by state), it is possible to create a “Dynasty 529 plan,” through which educational costs might be covered for several successive generations.
Though not necessarily the only solution in every case, 529 Plans remain a primary resource for educational funding. Given prohibitive college costs, the nuances of various state plans, investment options, and tax laws, and the impact of college planning on other household goals, some knowledge of these plans is needed to facilitate sound decisions.
For more information on 529 Plans, consult your Wealth Manager. (Note: this discussion has not addressed 529 ABLE accounts, which are for the benefit of certain eligible disabled persons, and which carry their own rules and stipulations.)
