Are you worried about the rising cost of education? 529 plans can be powerful college savings tools when you understand how to take full advantage of them.
Start with the Basics
529 plans are tax-advantaged college savings plans sponsored by a state or state agency, and there are two types:
Make Your Plan Work for You
When timed appropriately, contributions and withdrawals can help maximize your 529 plan. With most plans:
The CliffsNotes on contributions. To qualify as a 529 plan under federal rules, a state program can’t accept contributions more than the anticipated cost of attendance for the most expensive schools in the country. Most states have contribution limits of $350,000 and up per beneficiary.
The type of plan determines the limits:
Should you fund your plan in a lump sum or over time?
Timing is everything! Although 529 plans are tax-advantaged accounts, potential federal tax impacts are something to keep in mind. Under special rules unique to 529 plans, you can gift a lump sum of up to five times the annual gift tax exclusion—$75,000 for individual gifts or $150,000 for joint gifts—and avoid federal gift tax, provided you make an election on your tax return to spread the gift evenly over five years. (The federal gift tax exclusion is $15,000 for 2021.)
Withdrawals should also be coordinated with education tax credits—the American Opportunity Credit and Lifetime Learning Credit—because tuition expenses used to qualify for a credit can’t be the same tuition expenses paid with tax-free 529 funds.
What About Financial Aid?
During the financial aid process, income and assets are examined to determine how much the student should be expected to pay for school before receiving financial aid. To maximize the beneficiary’s future financial aid options, pay close attention to who is listed as the owner of your 529 plan.
How to handle 529 plans owned by parents. The value of any parent-owned 529 plan will be listed as an asset on the Free Application for Federal Student Aid (FAFSA). Colleges and the federal government typically treat 5.64 percent of parental assets as available to help pay college costs. By contrast, student assets are assessed at a rate of 20 percent.
Here are some additional things to keep in mind about parent assets:
What about grandparent-owned 529 accounts? If a grandparent is the account owner, the 529 plan doesn’t need to be listed as an asset on the FAFSA. Withdrawals from a grandparent-owned 529 account, however, are counted as student income—which is assessed at 50 percent—on the FAFSA the following year. This means financial aid eligibility could decrease by 50 percent in the year following the withdrawal. Grandparents may want to wait until their grandchild’s last two years of college to make a withdrawal if they are concerned about the potential impact on financial aid.
Preparation Is Key
You should review all your options to ensure that you’re financially prepared for education expenses. If you’d like to discuss 529 plans—or any other options—or if you have any questions about the information presented here, please contact me or my office.
* An applicant who qualifies for the simplified needs test may still be required to report assets on the FAFSA if they live in a state that requires asset information to determine eligibility for state grant programs. The asset information will be used only to determine eligibility for state grant programs. It won’t be used to determine eligibility for federal student aid. The states include Colorado, Georgia, Hawaii, Illinois, Minnesota, New Jersey, New Mexico, Ohio, Oklahoma, South Carolina, Vermont, Washington, Washington D.C., Wisconsin, and Wyoming.
This material has been provided for general informational purposes only and does not constitute either tax or legal advice. Although we go to great lengths to make sure our information is accurate and useful, we recommend you consult a tax preparer, professional tax advisor, or lawyer.
The fees, expenses, and features of 529 plans can vary from state to state. 529 plans involve investment risk, including the possible loss of funds. There is no guarantee that a college-funding goal will be met. To be federally tax free, earnings must be used to pay for qualified higher education expenses. The earnings portion of a nonqualified withdrawal will be subject to ordinary income tax at the recipient’s marginal rate and subject to a 10 percent penalty. By investing in a plan outside your state of residence, you may lose any state tax benefits. 529 plans are subject to enrollment, maintenance, and administration/management fees and expenses.