Changes Make 529 Even Better for Education Savings

July 11, 2018|

We are often asked about saving for future education costs. A 529 plan is an excellent way to do this.

Even better, thanks to the passage of tax reform legislation in 2017, 529 plans are now available to those wishing to save for a child’s K-12 education as well as college or vocational school.

You may open a Section 529 plan in any state, and there are no income restrictions for the individual opening the account. Contributions, however, must be in cash, and the total amount must not be more than is reasonably needed for higher education (as determined initially by the state). There may also be a minimum investment required to open the account, typically $25 or $50.

Each 529 Plan has a designated beneficiary (the future student) and an account owner. The account owner may be a parent or another person and typically is the principal contributor to the program. The account owner is also entitled to choose (as well as change) the designated beneficiary.

Neither the account owner nor beneficiary may direct investments, but the state may allow the owner to select a type of investment fund (e.g., fixed income securities) and change the investment annually as well as when the beneficiary is changed. The account owner decides who gets the funds (can pick and change the beneficiary) and is legally allowed to withdraw funds at any time, subject to tax and penalties (more about this below).

Unlike some of the other tax-favored higher education programs such as the American Opportunity and Lifetime Learning Tax Credits, federal tax law doesn’t limit the benefit only to tuition. Room, board, lab fees, books and supplies can be purchased with funds from a 529 savings account.

Individual state programs could have a more narrow definition, however, so be sure to check with your particular state.

Distributions from 529 plans are tax-free as long as they are used to pay qualified higher education expenses for a designated beneficiary. Distributions are tax-free even if the student is claiming the American Opportunity Credit, Lifetime Learning Credit or tax-free treatment for a Section 530 Coverdell distribution, provided the programs aren’t covering the same specific expenses.

Qualified expenses include tuition, required fees, books, supplies, equipment and special needs services. For someone who is at least a half-time student, room and board also qualifies. Also, starting in 2018, “qualified higher education expenses” include up to $10,000 in annual expenses for tuition in connection with enrollment or attendance at an elementary or secondary public, private or religious school.

Contributions made by the account owner or other contributor are not deductible for federal income tax purposes, but many states offer deductions or credits. Earnings on contributions grow tax-free while in the program. Distribution for a purpose other than qualified education is taxed to the one receiving the distribution.

In addition, a 10 percent penalty must be imposed on the taxable portion of the distribution, comparable to the 10 percent penalty in Section 530 Coverdell plans. Also, the account owner may change the beneficiary designation from one person to another in the same family. Funds in the account roll over tax-free for the benefit of the new beneficiary.

Remember, if you are interested in setting up a 529 plan for a young person in your life, that child does not need to be a relative. Any person can set up a plan for a designated beneficiary. Financial advisors are well versed on the subject, so contact yours if you are interested in setting up a plan. An investment in a child is an investment in the future!

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