Not everyone understands the finer points of 529 college savings plans. They are a great way to take advantage of potential tax savings and grow an investment in a simple and flexible way. But did you know these secrets that families can take advantage of?
1. Families can choose to “superfund” a 529 plan. A wealthy grandparent or relative who would like to make a generous contribution to a 529 can superfund the plan up to $70,000 in a single year without facing a gift tax penalty. In most cases, the gift tax comes into play for amounts over $14,000 in a single year. The amount is transferred out of the donor’s estate and into a tax-deferred (and potentially tax-free) investment for college. Superfunding treats the gift as if it came in over a five-year period–a great estate planning tip for grandparents or a rich uncle.
2. The family has been working so hard to save for their student, and then the talented child gets a scholarship. What to do with the money saved? Well, there are several options, but they may not have known they can make a withdrawal from the 529 in the dollar amount of the scholarship without paying the 10% penalty. The withdrawal is not for qualified expenses like tuition or room and board because these are being covered by the scholarship. Normally, this type of non-qualified withdrawal would be subject to a 10% penalty. In this case the earnings portion of the withdrawal would be taxable but would not be subject to the penalty.
3. Age is only a number. The beneficiary on a 529 plan does not have to be a child. There is no age restriction on 529 plans. Even grandmas and grandpas can go back to school and use funds from a 529.
4. You don’t have to put all the eggs in one basket. If it makes sense for your client, take advantage of their state’s tax credit and invest in their state’s plan. If they have additional money to save, they can invest it in another state’s 529 plan that may have lower fees or additional investment options not available in their state’s 529 plan. It also important to note that the funds in a 529 plan can be used at any accredited institution across the globe, regardless of the state that administers the plan.
5. When thinking about qualified expenses, don’t limit your thinking to just tuition, room, and board. Expand your thinking a bit. Basically, anything students are required to have as part of their college education can be covered. Computers…yes. Internet service…yes. Required course fees…yes. But some things that are not included: fees for elective activities like sports or extracurriculars, parking passes (the IRS does not think you need to have a car on campus), or entertainment costs.
6. Most 529 plans offer a combination of cash, fixed income (bonds), and stock based investments. Typically mutual funds or exchange traded funds are not included. Be aware how adjustments in the market will affect savings. Many offer a “done for you” age based portfolio that adjusts the portfolio’s asset allocation to an appropriate risk level as the student gets closer to needing the funds. A good idea is to check in with the plan at least once a year to see how it is performing. Most plans allow owners to change the investment portfolio at least once a year or if the beneficiary is changed. Be familiar with how the plan works.
7. If thinking about private college, families might want to consider the Private College 529 plan. It is not an investment and it functions much like a “pre-paid” tuition plan. No matter how much tuition increases over the years, or how volatile the financial markets are, families are buying tomorrow’s tuition at today’s prices in the form of what they refer to as “tuition certificates.” The increase in value and distributions are federal tax free when used to pay for college just like other 529 plans. Owners name a beneficiary when they open their account but don’t select a college or university until the student enrolls. The money saved in the plan can be used to pay for the cost of attending over 300 leading private colleges and universities nationwide including top schools like Stanford, Princeton, TCU, Notre Dame, Kenyon, Case Western Reserve, John Carroll, and hundreds more. Essentially, you lock in current rates that can be used at any of the participating colleges and universities. Private College 529 is the only 529 plan not run by a state. Participating colleges and universities own the Plan, and they guarantee the prepaid tuition.
8. Military academies are an amazing opportunity to earn an outstanding education and afterwards serve our country. They are also free if a student commits to serve after graduation. So, what do you do with saved 529 money? The owner always have the option to transfer the beneficiary to another child or even themselves. If not, they can withdraw the funds and avoid the 10% penalty tax. The Military Family Tax Relief Act of 2003 provides that if a student attends a U.S. military academy this will be treated as a scholarship for purposes of non-qualified withdrawals from a 529 plan. However, like a scholarship we mentioned in #2, the earnings portion of the account will be taxable.
9. We hope families never have to deal with this one…the death or disability of a 529 beneficiary. In the event of the death of a plan’s beneficiary, the owner can transfer the beneficiary to another member of the family, or they can elect to authorize a payment to the estate of the deceased. Although subject to federal, state, and local taxes, the earning portion will not be subject to the 10% penalty. If the beneficiary becomes permanently disabled, they may select a new beneficiary or withdraw all or part of the money from the account. Just as in the event of a death, the earnings portion is not subject to a penalty but will be subject to taxes.
10. Don’t limit 529 thinking to traditional 4-year colleges. The owner can use their 529 savings at many types of post high school learning institutions like trade schools, community colleges, graduate school, international schools, theological seminaries, or online colleges. Trade schools can include a wealth of different places like cosmetology, culinary, or technical colleges. If an owner has funds remaining after a 4-year degree, they can continue to use those funds for graduate, medical, or law school among others. About 400 international schools also qualify. The IRS keeps a list of eligible institutions. (The current Excel spreadsheet is 6,784 rows long!)
11. And finally, rollovers. An owner can choose to move their funds from one 529 plan to another, and sometimes they can do so without penalty. If they rollover funds from one plan to another for the same beneficiary, they will not face penalty or taxes. However, they cannot have rolled over funds for that same beneficiary within the last 12 months. If they move funds from one plan to another and change the beneficiary, they will face no penalty if that new beneficiary is a member of the previous beneficiary’s family. Be aware if the owner moves money from one state’s plan to another, and you received tax credit on your original deposits, the state may look for to the owner to pay back those tax credits they received. So, be careful when making these changes.
Get all that? Understanding all the ins and outs and finer points of 529 plans can help your clients be more informed consumers of a college education.