Most people invest in a 529 Savings Plan in order to provide for college education for their children. However, these plans can be excellent estate planning tools as well.
What is a 529 Savings Plan?
There are two types of college tuition savings programs offered through the states: pre-paid tuition, and savings plans. Both utilize Section 529 of the Internal Revenue Code, which grants tax advantages to people who invest in education plans. States can offer either or both types of plans, and you do not need to be a resident of a particular state in order to buy in to their 529 plans. In this article, I will focus primarily on Savings Plans, rather than prepaid tuition plans.
Better than a Roth IRA?
One significant benefit to 529 Savings Plans is that contributions to 529 Savings Plans are made with after-tax dollars, similar to a Roth IRA. Earnings accumulate on a tax-deferred basis, and distributions are entirely tax-free if used to pay for qualified expenses. There are no annual contribution limits, other than the annual gift tax exclusion. Aggregate limits, once reached, still allow for earnings to accumulate. Additionally, more than 30 states offer a state income tax break on contributions to their state’s 529 plans, making them superior to a Roth IRA. Seven states provide a state income tax deduction or tax credits for contribution to any state’s 529 plan.
A 529 Savings Plan also allows the owner to retain control of the account. The beneficiary can be changed to the owner to pay for their own education or retrain after job loss, or it can be changed to the beneficiary’s children, or other relatives. There is no time or age limits, so the money may remain in the account and continue to grow indefinitely.
What can the money be spent on?
529 Savings Plans offer the broadest list of qualified expenses, including tuition and fees, room and board, books, supplies and equipment, computers, software, and special needs expenses. The main college costs not covered are transportation, health insurance, and personal expenses. The funds can be used for in-state, out-of-state, or private universities; two-year or four-year colleges, graduate and professional school, and even up to $10,000 per year for K-12 tuition. There is no age limit, and the beneficiary does not need to be pursuing a degree or certificate, so it can be used for continuing education or just for fun.
If the beneficiary becomes disabled, the money can also be transferred into an ABLE account. In this situation, however, it would be wise to keep the balance low as any amount remaining in the account upon the death of the beneficiary is recaptured by the state.
Are there any drawbacks?
The value of the 529 plan can affect the student’s financial aid. This affects both the federal aid as well as financial aid from universities and colleges directly.
Another potential drawback is the 10% withdrawal penalty for non-qualified distributions. This penalty can be waived under certain circumstances, including:
A beneficiary dies or becomes disabled
A beneficiary receives a tax-free scholarship
A beneficiary receives educational assistance through a qualifying employer program
A beneficiary attends a U.S. Military Academy
The qualified education expenses were used to generate the American Opportunity Tax Credit (AOTC) or the Lifetime Learning Tax Credit (LLTC)
These distributions are also taxable as income, both federally and sometimes at the state level as well.
Ready to learn more?
529 Savings Plans offer substantial benefits for families who use them in their estate planning. Call me today to talk about whether a 529 Saving Plan might be a beneficial part of your estate plan.
