Benefits of 529 Plans

529 Plans have benefits beyond tax-deferred earnings which make them attractive options for educational funding.

I’ve been discussing 529 plans, how they work and their benefits far more frequently with clients than I used to.  You might think that tax-deferred savings is the main benefit, along with tax-free withdrawals for qualifying higher education expenses in 529 plans. However, there are also state tax incentives, such as tax deductions, credits, grants, or exemption from financial aid consideration from in-state schools in certain states.  Forbes’ recent article entitled “7 Benefits You Didn’t Know About 529 College Savings Plans (But Should)” says there are many more advantages to the college savings programs than simple tax benefits.

1) Registered Apprenticeship Programs Qualify. You can make qualified withdrawals from a 529 plan for registered apprenticeship programs. These programs cover a wide range of areas with an average annual salary for those that complete their apprenticeship of $70,000.

2) International Schools Usually Qualify. More than 400 schools outside of the US are considered to be qualified higher education institutions. You can, therefore, make tax-free withdrawals from 529 plans for qualifying expenses at those colleges.

3) Gap Year and College Credit Classes for High School. Some gap year programs have partnered with higher education institutions to qualify for funding from 529 accounts. This includes some international and domestic gap year, outdoor education, study-abroad, wilderness survival, sustainable living trades and art programs. Primary school students over 14 can also use 529 plans for college credit classes, where available.

4) Get Your Money Back if Not Going to College. If your beneficiary meets certain criteria, it’s possible to avoid a 10% penalty and changing the plan from tax-free to tax-deferred. For this to happen, the beneficiary must:

  • Receive a tax-free scholarship or grant
  • Attend a US military academy
  • Die or become disabled; or
  • Get assistance through a qualifying employer-assisted college savings program.

Note that 529 plans are technically revocable. Therefore, you can rescind the gift and pull the assets back into the estate of the account owner. However, there are tax consequences, including tax on earnings plus a 10% penalty tax.

5) Private K–12 Tuition Is Qualified. 529 withdrawals can be used for up to $10,000 of tuition expenses at private K–12 schools. However, other expenses, such as computers, supplies, travel and other costs are not qualified.

6) Pay Off Your Student Loans. If you graduate with some money leftover in a 529 account, it can be used for up to $10,000 in certain student loan repayments.

7) Estate Planning. Contributions to a 529 plan are completed gifts to the beneficiary. These can be “superfunded” for up to $75,000 per beneficiary in a single year, effectively using five years’ worth of annual gift tax exemption up front. For retirees with significant RMDs (required minimum distributions) from qualified accounts, such as 401(k)s and traditional IRAs, the 529 plan offers high contribution limits across multiple beneficiaries, while retaining control of the assets during the lifetime of the account owner. Assets also pass by contract upon death, avoiding probate and estate tax.

7.5) Medicaid Benefit.  I’m going to cheat and add one more.  In Texas, transfers to 529 plans for CERTAIN beneficiaries are exempt as transactions for longterm Medicaid.  As with all Medicaid planning, you would want to do this at the advice of an attorney, but for situations where it fits, it is a very powerful spend down tool, especially where grandchildren are school age.

Reference: Forbes (July 15, 2021) “7 Benefits You Didn’t Know About 529 College Savings Plans (But Should)”

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How Grandparents Can Help Pay For College

Grandparents wanting to help pay for a grandchild's education may with to consider a 529 Plan.
Grandparents wanting to help pay for a grandchild’s education may with to consider a 529 Plan.

If you are a grandparent wondering how you can help pay for a grandchild’s future college education, you may wish to consider a Qualified Tuition Plan under IRC Section 529, otherwise known as a 529 plan.

Forbes’ recent article entitled “Estate Planning Primer: Qualified Tuition Plans” explains that there are two kinds of 529 programs that can help pay for college (and some other education expenses): prepaid plans and savings plans. The earnings on the assets in the 529 plan aren’t taxed, until the funds are distributed. The distributions are also tax-free up to the amount of the student’s “qualified higher education expenses.”

One kind of 529 plan is known as a prepaid plan. With this plan you buy tuition credits at the current tuition rates, even though your grandchild may not be starting college for several years. Because the cost of a college education rises every year, there is a substantial benefit to being able to lock in the cost at today’s rate.

The other kind of 529 plan is a savings plan. Even though the earnings in the plan are tax deferred and, to the extent used for qualified higher education expenses, tax-free, the amount available to pay the college costs depends on the investment performance of the plan. The more the funds in the plan grow, the more education costs can be covered. But if the value of the plan declines, fewer education costs will be covered.

Qualified higher education expenses include tuition, fees, books, supplies, and required equipment. Reasonable room and board may be considered a qualified expense, if the student is enrolled at least half-time. Distributions of income from the 529 plan in excess of qualified expenses are taxed to the student, and may result in 10% penalty.

You would designate you grandchild as beneficiary of the 529 plan at the time you create it. However, you are able to change the beneficiary or roll over the funds in the plan to another plan for the same or a different beneficiary.

A 529 plan may be used to fund a grandchild’s education at any college, university, vocational school, or other post-secondary school eligible to participate in a student aid program of the Department of Education.

Any funds you contribute to the 529 plan will be treated as gifts to your grandchild; however they qualify for the annual gift tax exclusion ($15,000 per person per year for 2020) adjusted annually for inflation. If you contribute more than the annual exclusion amount in a given year, you can elect to have the gift treated as being made over a five-year period starting with the year of the contribution.

While you may name yourself as custodian of the 529 plan, it is important to also designate a successor custodian, perhaps a parent of a grandchild, in the event you are not able to act as custodian.

Reference: Forbes (Aug. 5, 2020) “Estate Planning Primer: Qualified Tuition Plans”

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