May 29th marks another year of National 529 Plan Day, a day to raise awareness about the benefit of saving for college through a 529 college savings plan. According to the College Board’s Trends in College Pricing, the average cost for tuition and fees at four-year public institutions has increased almost 40% over the last decade after adjusting for inflation. Fortunately, 529 plans can help ease this financial burden by offering families a tax-efficient means of saving for college.
What is a 529 Plan?
A 529 plan is a state-sponsored tax-advantaged savings plan that is designed to help you pay for education expenses. In a 529 plan, your earnings grow tax-deferred and can be withdrawn tax-free if used to pay for qualified education expenses. Each state offers at least one 529 plan and there is no requirement for attending an institution within that state if that state’s 529 plan is utilized.
How Much can you Contribute?
You can contribute up to $16,000 per beneficiary ($32,000 for married couples) to a 529 plan without needing to file a gift tax return. Any excess contributions, however, will count against your lifetime estate and gift tax exemption which is $12.06 million per person ($24.12 million for married couples) in 2022.
You can also contribute up to $80,000 per beneficiary in a single year ($160,000 for married couples) and elect to treat the contribution as if it were made over five consecutive years. This strategy can help you make a large 529 plan contribution without eating into your lifetime estate and gift tax exemption.
What Counts as a Qualified Expense?
You can use 529 plan funds for a wide range of education-related expenses. Qualified expenses for higher education include tuition, mandatory fees, books, supplies, and computers, just to name a few. Room and board is also considered a qualified expense as long as the student is enrolled at least half-time.
You can also withdraw up to $10,000 per year in K-12 tuition expenses for the beneficiary and a lifetime maximum of $10,000 to pay down student loan debt for the beneficiary and each of their siblings. Bear in mind that these are federal laws so you should check your state’s definition of qualified expenses before taking a distribution.
529 plan withdrawals also must be taken during the same calendar year—not the same academic year—in which the qualifying expenses are paid otherwise the distribution may be a non-qualified distribution. To simplify record keeping and ensure accurate matching, you may want to elect to make payments directly from your 529 plan to your student’s institution.
What Happens if you Don't Utilize all the Money in Your 529 Plan?
Typically, if you don’t use your 529 plan for qualified expenses, your earnings may be subject to tax and a 10% penalty. However, there are several options you may want to consider to avoid paying taxes and a penalty. First, you can maintain the 529 plan, allow the funds to continue to grow, and use them for graduate school or a professional business program. This might be a good option if your child has aspirations to pursue a career that requires more advanced education.
Another option would be to switch the beneficiary to another qualified family member. You could also switch the beneficiary to yourself and take classes (cooking, art, foreign languages, etc.,) at an eligible educational institution.
Lastly, you may qualify for a penalty-free withdrawal under certain circumstances. For example, if your child receives a scholarship, you can withdraw up to the amount of the award from your 529 plan. However, you would still owe taxes on the earnings portion of the withdrawal.
Does a 529 Plan Affect Financial aid?
Many people delay saving money into a 529 plan—or do not use one at all—because they are concerned that it might impact their child’s chances of qualifying for financial aid in the future. While a 529 plan can affect your child’s financial aid, the impact is limited and varies depending on the account owner.
Eligibility for federal financial aid is currently determined by the Expected Family Contribution (EFC). If a parent owns the 529 plan, typically up to 5.64% of the value will be factored into the EFC. When distributions are made to pay for college education expenses, however, the funds are not counted at all. If a grandparent owns the 529 plan, on the other hand, the value is not factored into the EFC but under current rules, distributions must be reported as untaxed student income which can reduce financial aid eligibility by up to 50% of the amount of the distribution received.
The FAFSA Simplification Act was passed recently and will make changes to the processes for determining federal financial aid eligibility. As part of the FAFSA Simplification Act, the EFC will be replaced with the Student Aid Index (SAI). The SAI is expected to increase income protection allowances for both parents and students and remove certain income sources (such as grandparent-owned 529 plans) from the student’s aid eligibility calculation. The provisions are currently slated to have a phased implementation that will extend to the 2024-2025 academic year.
A 529 plan is one of the best tax-advantaged ways to save for higher education. However, it is important to review your unique circumstances to determine whether a 529 plan is appropriate for you. If you would like to explore your options for saving for education, your Aldrich Wealth team is here to help you.
MEET THE EXPERT
Tyler Conroy, CFP®
Aldrich Wealth LP
Tyler Conroy joined Aldrich Wealth in 2019. Before joining the firm, Tyler spent several years as an Associate Financial Consultant with Charles Schwab. He has particular expertise in providing comprehensive wealth management and financial planning services. Tyler enjoys educating individuals and families on how to play an active role in their financial well-being. Tyler earned…
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