529 Plan Features
In 1996, Congress passed a law creating the 529 Plan to help families save for college. The 529 plan allows you to contribute to an account where the money grows tax deferred. If you use the money to pay for qualified education expenses, then the distribution is federal tax free. Many people understand the tax advantages of the 529 plan. However there are a few lesser known features you should also take into consideration.

How Much You Can Contribute

Each state sets a lifetime contribution limit for every 529 plan beneficiary. The range is between $235,000 to $550,000. There is no annual contribution limit. However, the IRS considers contributions to 529 plans as a completed gift. In 2022, you could give up to $16,000 per recipient. Contributions over $16,000 will count against the taxpayer’s lifetime estate and gift tax exemption, and the taxpayer must file tax Form 709.

You could also make a lump sum contribution up to $80,000 into a 529 plan and treat it as if the contributions were spread over a 5 year period ($16,000 per year). You would not have to file IRS Form 709 for this, but you would not be eligible to contribute to a 529 plan for that beneficiary for 5 years. This could be a good estate planning strategy for anyone who wants to give more than the current $16,000 limit without affecting his or her lifetime estate and gift tax exemption.

Federal and State Tax Deduction on Contributions

You do not get a federal income tax deduction on your contribution. However many states will give you an income tax deduction or tax credit. The amount of deduction or credit varies by state.

Federal and State Taxation on Distributions

If the money is used for a qualified expense, then you will not owe federal income taxes on the distribution. In most cases, this is also true for state income taxes. However, a few states have unique rules. For example, let’s look at Alabama’s state income tax rules. If you live in Alabama and have a non-Alabama 529 plan and use that money to pay college expenses, then the distribution is taxable on your Alabama state income taxes. Please consult your state for more information.

You Can Invest in any State’s 529 Plan and Attend any College or University

Each state has its own 529 plan. You could invest in your current state’s 529 plan or invest in another state’s plan. For example, if you live in Missouri, you could invest in Kansas’ 529 plan. You are allowed to use the 529 plan to pay for colleges in any state.

Money Can Be Used for Primary and Secondary Education

Originally 529 plans were used to pay qualified college expenses (tuition, room, board, books, etc.) In 2018 and 2019, Congress expanded the use of 529 plan money. Now you can spend up to $10,000 per student per year to cover tuition at elementary and secondary schools. You could also use the money to pay up to $10,000 of student loans.

Pay for Certain Business Expenses

If the student wants to start a business immediately after college, some of the business equipment could be considered a qualified expense if bought while the student was in college. For example, your child is majoring to become an architect and wants to start his or her architect firm after graduation. The computer, architect software and printer could be considered qualified expenses if bought while the student was still enrolled in courses. This equipment could then be used for the business after graduation. Please consult a tax advisor for more information.

Will You Lose Money in the 529 Plan if your Child Doesn’t go to College?

If your child decides not to go to college or doesn’t use all of the money in the 529 plan, then you could change the beneficiary to another family member (niece, nephew, grandchild, etc.). You could also name yourself as beneficiary if you decide to go back to school. There is no timeframe when the money in the 529 plan must be used.

Tax Penalty Could be Waived on Non-Qualified Distributions

If money is withdrawn for non-qualified expenses, then you would pay ordinary income taxes and a 10% penalty on the gains (not on the contribution amount). Below are a few situations where you could avoid paying the 10% penalty on non-qualified distributions. However you would have to pay ordinary income taxes on the gains.

 

  • Your child receives a scholarship, grant, veteran’s educational assistance or employer educational assistance. You could withdraw money from the 529 plan up to the dollar amount of the award received.
  • You withdraw money from the 529 plan up to the cost of the education at a military academy
  • Your child unfortunately died or became disabled.

Grandparent 529 Plans do not Affect Financial Aid Anymore

Starting in October 2022, the Department of Education will release a simplified version of the Free Application of Federal Student Aid Form (FASFA Form). Parents complete this form annually to apply for college financial aid. In the original FASFA Form, assets held in a grandparent-owned 529 plan (or other relative-oned 529 plan) are not reported on the FASFA form. However money withdrawn from a grandparent-owned 529 plan is considered to be untaxed income and is added to the student’s adjusted gross income on the FAFSA. The money withdrawn from the grandparent 529 plan could reduce financial aid eligibility up to 50% of the cash amount withdrawn. This created a disincentive for grandparents to contribute to a 529 plan.

In the simplified version of the FASFA Form, you do not need to report cash received from a grandparent-owned 529 plan. Therefore grandparent-owned 529 plans will not affect student financial aid.

Disclaimer: Information provided is for educational purposes only and does not constitute investment, legal or tax advice. All examples are hypothetical and for illustrative purposes only. Past performance of any market results is no assurance of future performance. The information contained herein has been obtained from sources deemed reliable but is not guaranteed. Please contact TRPG for more complete information based on your personal circumstances and to obtain personal individual investment advice.