It’s that time of year again: To the collective relief of parents nationwide, the school year is about to begin. And with that, now is as good a time as any to review 529 education savings plans. After all, the 529 plan remains extremely popular, with over $319 billion in assets, according to some estimates. But 529 plans are also complicated, with very specific rules and regulations, and mistakes in the form of penalties or taxes are costly.
Here’s what you need to know about 529 plans:
What is a 529 plan? The name 529 comes from a section in the IRS tax code. Section 529 Qualified Tuition Programs are investment accounts administered by each state and intended to be used for qualified education expenses.
What are the tax benefits? Generally speaking, the earnings on 529 plan contributions can grow free from federal income tax, and withdrawals used to pay for qualified education expenses are free from federal income tax as well. Contributions are with after-tax money; however, most states offer a state income tax deduction for contributions, but this varies for each state.
Do I have to use my state’s plan? No, you do not have to be a resident of that state to use another state’s plan. However, there may tax advantages to using your own state. It’s best to discuss with your accountant or financial adviser before opening an account.
What are “qualified” education expenses? Qualified education expenses include tuition, mandatory fees, textbooks, computers and software, supplies, required equipment and room and board if enrolled at least half-time. Room and board costs may not exceed certain amounts, either the actual invoiced cost of living on-campus or, if off-campus, the applicable rate determined by the qualified college or institution. Special needs services for a special needs beneficiary are also considered a qualified expense.
Does a 529 account have to be used for college? What about other schools, like a trade or vocation? 529 assets can be used at any eligible institution of higher learning. That includes four-year colleges, universities, qualifying two-year programs, trade schools and vocational schools. To qualify as an eligible institution, a school must be eligible to participate in student financial aid programs offered by the Department of Education.
Can 529 money be used for K-12 schools? A relatively new provision allows 529 account owners to withdraw up to $10,000 per year per student for private primary or secondary education. Unlike for college, this only applies to tuition, not to textbooks, computers or other fees or activities.
What if money is withdrawn for any other expense that isn’t considered “qualified”? Any earnings on a non-qualified withdraw are subject to a 10% federal tax penalty. In addition, the earnings are subject to federal and, if applicable, state income taxes.
Are there any exceptions to the 10% penalty? What if my child receives a scholarship? Withdrawals following a beneficiary’s death, disability or receipt of a scholarship (to the extent of the scholarship award) will not be subject to the 10% penalty. However, you will have to pay taxes on the earnings.
Who can open an account? Any individual who is of legal age to open an account and is a U.S. citizen or legal resident. In addition, U.S. trusts, corporations, partnerships and non-profit organizations may open an account.
Who is the owner? Typically, the parent is the owner. There can only be one owner, no joint ownership. However, there is an option for a successor owner if the account owner dies.
Who is the beneficiary? Usually the child, but it can be anyone — including yourself — and the beneficiary must be either a U.S. citizen or legal U.S. resident.
Who can contribute to the account? Any person or entity may make contributions to the account for the benefit of a beneficiary at any time.
What are the contribution limits? The IRS doesn’t specify an annual contribution limit. However, contributions are considered gifts for tax purposes. In 2018, gifts totaling up to $15,000 per individual will qualify for the annual exclusion. This means if you and your spouse have three children you can gift $90,000 without gift-tax consequences since each child can receive $15,000 in gifts from you and $15,000 in gifts from your spouse. Remember, this also includes non-529 gifts (such as gifts to a life insurance trust) so be sure to account for those.
Is there an overall limit to 529 plan accounts? Technically there are overall limits to 529 plan account balances. But limits can vary from state to state, generally from $235,000 to $520,000. Once the balance on a 529 plan reaches its limit, the plan will not accept new contributions. It’s worth mentioning some plans will consider balances in other 529 plans for an overall aggregate limit. For instance, if the owner has more than one 529 for the same beneficiary, the plan may aggregate all the plan’s balances to determine if the maximum limit has been reached.