This is part of our the Best Ways to Save for College series, today we will focus on 529 savings plan.
What is a 529 Plan
529 College Savings Plan is a Federally authorized, usually state-sponsored, tax advantaged plan focuses on savings for college. Independent financial institutions typically manage the plans on behalf of state sponsors. Private plans are also available.
What are the 529 Plan Tax Benefits
Does 529 Plan Have Contribution Limit
529 plans were designed to take large amounts of money, so the actual plan specific contribution limits often exceed $300,000. However, note that contributions to 529 Savings Plans are considered gifts to the beneficiary, therefore gift tax rules apply.
A gift tax return must be filed when the total of all gifts from one contributor to a beneficiary exceeds $14,000 in one calendar year (this is the 2013 limit and will rise with inflation over time). Contributors may put up to $70,000 (single) or $140,000 (married) into 529 Savings Plans (annual gift tax limit over a five year period).
How to Use 529 Plan Funds
To avoid income taxes and/or penalties, the funds in 529 plans MUST be used for qualified higher educational expenses at an eligible institution. These expenses include tuition, and mandatory fees, supplies, books, and equipment. Room and board expenses are also qualified expenses in semesters during which the student is enrolled at least as a half-time student.
Junior College, Technical College, Undergraduate, Professional, and Graduate level expenses can be qualified expenses.
How to Invest Funds in 529 Plan Accounts
Most plans have a specific college target date portfolios that lower the investment risk as the student gets closer to college. Many plans offer guaranteed return options. Account owners can choose from among the investments in the plan. Changes between options are allowed once a year and investments must remain in one choice for a year before a change can be elected.
Can a 529 Plan Account Be Transferred
A 529 plan could be “rolled over” to another member of the beneficiary’s immediate family, such as siblings, stepsiblings, half-siblings, parents, grandparents, children, grandchildren, and first cousins of the beneficiary, and anyone married to any of these people (except cousins).
Who Controls 529 Plan Account
Account owner controls the account at all times. There is no transfer of control to the beneficiary during the lifetime of the account owner.
What If 529 Plan Not Used For Qualified Expenses
Taxes and perhaps penalties apply in this situation. The earnings portion of the non-qualified withdrawal is subject to federal, state and local taxes to the recipient of the funds and will be subject to a federal penalty of 10% of withdrawn earnings. States may require the repayment (called recapture) of any state income tax deductions that were available when the funds were contributed. Plans and states may apply a penalty as well.
Exceptions: If the non-qualified withdrawal is made in an amount equal to or less than a scholarship, or if the student received a military academy appointment and enrolled in an academy, then the earnings from the withdrawal are subject to the above mentioned taxes, but are not subject to the 10% additional penalty.
If a 529 Savings Plan has lost value and the participant makes a non-qualified withdrawal, they will receive the value of the account without penalty, but may still be subject to recapture of past tax breaks on the state income tax return.
Some plans allow the participant to make a non-qualified distribution to the account beneficiary, instead of themselves. If the participant takes this option, then the income tax and penalties (if applicable) will be assessed at the beneficiary’s tax rate.
Does 529 Plan Impact Financial Aid
529 Savings Plan balances are counted as parents' assets, therefore are favorably treated in the federal and state financial aid formulas.
If the account is owned by grandparents or others who are not asked to provide information on the applications, its value will have no impact on the student’s eligibility for federal financial aid. However, effective with the 2010-2011 academic year, students are required to report payments from 529 Savings Plans owned by people outside of the custodial household as untaxed income on their aid applications. This income may have a large impact on financial aid for the year after the withdrawal is made. Some private colleges may include the value of these accounts in their formulas, or may treat withdrawals from these accounts as though they were scholarships. You need to contact colleges directly if this is a concern.
Most state financial aid programs exempt some assets in 529 Savings Plans from their formulas for determining state based financial aid.
What Else Should I Know About 529 Plans
Eligible Institutions
All schools that are eligible to participate in federal financial aid programs (University, College, Community College, Proprietary, Trade, and Technical) are eligible institutions. The beneficiary of a 529 Savings Plan must be taking classes at an eligible institution in order for the participant to qualify for the 529 Savings Plan tax benefits. The eligible institution does not have to be in the state that the student lives, or the state that sponsors the 529 Savings Plan.
Some colleges in the United States are not qualified educational institutions. Many, but not most non-US colleges are eligible institutions. The web site for the Free Application for Federal Student Aid (FAFSA), www.fafsa.gov, has a search feature that allows students to determine if a college is an eligible institution. This feature is located at the link for “find a school code” in the “before you file” column on the FAFSA home page.
Can I Invest in Another State's 529 Plan
If you are not satisfied with your own state’s 529 Savings Plan, you can consider another state’s program. But first you should check to see if your own state’s plan provides a state tax deduction for in-state contributions, bonus payments, or imposes taxation or penalties on out-of-state 529 Savings Plans.
What Is I am NOT a U.S. Tax Payer
The 529 Plan's tax benefits apply only to taxpayers who pay income tax to the United States. Individuals who might live outside of the United States, or who will be subject to another country’s income tax code before or during their children’s college career, may want to avoid 529 Savings Plans because these other countries may subject even qualified withdrawals from these plans to their own investment taxation rules.
Parents may not take money from UTMA/UGMA accounts to fund 529 Savings Plans that the parents own.
What is a 529 Plan
529 College Savings Plan is a Federally authorized, usually state-sponsored, tax advantaged plan focuses on savings for college. Independent financial institutions typically manage the plans on behalf of state sponsors. Private plans are also available.
What are the 529 Plan Tax Benefits
- Contributions: Not deductible for federal tax purposes, but may be deductible on state and local income tax returns. Check your state's 529 plan website for details
- Growth: Tax-deferred
- Withdrawals: Earnings are tax-free when used to pay for the beneficiary’s qualified education expenses. In August 2006, Congress made this treatment permanent. Earnings are usually exempt from state and local taxes.
Does 529 Plan Have Contribution Limit
529 plans were designed to take large amounts of money, so the actual plan specific contribution limits often exceed $300,000. However, note that contributions to 529 Savings Plans are considered gifts to the beneficiary, therefore gift tax rules apply.
A gift tax return must be filed when the total of all gifts from one contributor to a beneficiary exceeds $14,000 in one calendar year (this is the 2013 limit and will rise with inflation over time). Contributors may put up to $70,000 (single) or $140,000 (married) into 529 Savings Plans (annual gift tax limit over a five year period).
How to Use 529 Plan Funds
To avoid income taxes and/or penalties, the funds in 529 plans MUST be used for qualified higher educational expenses at an eligible institution. These expenses include tuition, and mandatory fees, supplies, books, and equipment. Room and board expenses are also qualified expenses in semesters during which the student is enrolled at least as a half-time student.
Junior College, Technical College, Undergraduate, Professional, and Graduate level expenses can be qualified expenses.
How to Invest Funds in 529 Plan Accounts
Most plans have a specific college target date portfolios that lower the investment risk as the student gets closer to college. Many plans offer guaranteed return options. Account owners can choose from among the investments in the plan. Changes between options are allowed once a year and investments must remain in one choice for a year before a change can be elected.
Can a 529 Plan Account Be Transferred
A 529 plan could be “rolled over” to another member of the beneficiary’s immediate family, such as siblings, stepsiblings, half-siblings, parents, grandparents, children, grandchildren, and first cousins of the beneficiary, and anyone married to any of these people (except cousins).
Who Controls 529 Plan Account
Account owner controls the account at all times. There is no transfer of control to the beneficiary during the lifetime of the account owner.
What If 529 Plan Not Used For Qualified Expenses
Taxes and perhaps penalties apply in this situation. The earnings portion of the non-qualified withdrawal is subject to federal, state and local taxes to the recipient of the funds and will be subject to a federal penalty of 10% of withdrawn earnings. States may require the repayment (called recapture) of any state income tax deductions that were available when the funds were contributed. Plans and states may apply a penalty as well.
Exceptions: If the non-qualified withdrawal is made in an amount equal to or less than a scholarship, or if the student received a military academy appointment and enrolled in an academy, then the earnings from the withdrawal are subject to the above mentioned taxes, but are not subject to the 10% additional penalty.
If a 529 Savings Plan has lost value and the participant makes a non-qualified withdrawal, they will receive the value of the account without penalty, but may still be subject to recapture of past tax breaks on the state income tax return.
Some plans allow the participant to make a non-qualified distribution to the account beneficiary, instead of themselves. If the participant takes this option, then the income tax and penalties (if applicable) will be assessed at the beneficiary’s tax rate.
Does 529 Plan Impact Financial Aid
529 Savings Plan balances are counted as parents' assets, therefore are favorably treated in the federal and state financial aid formulas.
If the account is owned by grandparents or others who are not asked to provide information on the applications, its value will have no impact on the student’s eligibility for federal financial aid. However, effective with the 2010-2011 academic year, students are required to report payments from 529 Savings Plans owned by people outside of the custodial household as untaxed income on their aid applications. This income may have a large impact on financial aid for the year after the withdrawal is made. Some private colleges may include the value of these accounts in their formulas, or may treat withdrawals from these accounts as though they were scholarships. You need to contact colleges directly if this is a concern.
Most state financial aid programs exempt some assets in 529 Savings Plans from their formulas for determining state based financial aid.
What Else Should I Know About 529 Plans
Eligible Institutions
All schools that are eligible to participate in federal financial aid programs (University, College, Community College, Proprietary, Trade, and Technical) are eligible institutions. The beneficiary of a 529 Savings Plan must be taking classes at an eligible institution in order for the participant to qualify for the 529 Savings Plan tax benefits. The eligible institution does not have to be in the state that the student lives, or the state that sponsors the 529 Savings Plan.
Some colleges in the United States are not qualified educational institutions. Many, but not most non-US colleges are eligible institutions. The web site for the Free Application for Federal Student Aid (FAFSA), www.fafsa.gov, has a search feature that allows students to determine if a college is an eligible institution. This feature is located at the link for “find a school code” in the “before you file” column on the FAFSA home page.
Can I Invest in Another State's 529 Plan
If you are not satisfied with your own state’s 529 Savings Plan, you can consider another state’s program. But first you should check to see if your own state’s plan provides a state tax deduction for in-state contributions, bonus payments, or imposes taxation or penalties on out-of-state 529 Savings Plans.
What Is I am NOT a U.S. Tax Payer
The 529 Plan's tax benefits apply only to taxpayers who pay income tax to the United States. Individuals who might live outside of the United States, or who will be subject to another country’s income tax code before or during their children’s college career, may want to avoid 529 Savings Plans because these other countries may subject even qualified withdrawals from these plans to their own investment taxation rules.
Parents may not take money from UTMA/UGMA accounts to fund 529 Savings Plans that the parents own.
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