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Saving for School: 529 Plan Tips

October 17, 2017

If you’re not familiar with 529 plans, you will be by the time you finish this article. First, a quick definition: 529 plans are a savings vehicle specifically designed to help you save money to cover the costs of higher education. 529 plans also offer the added benefit of significant tax benefits, which we outline here.

To begin, it’s important to understand the two types of 529 plans: 529a and 529b. Both allow funds to grow tax-deferred and to be used tax-free for qualifying education expenses. However, 529a plans, also known as prepaid tuition plans, let you purchase tuition credits now for use in the future. On the other hand, with a 529b plan, contributions are invested in specific investment portfolios with a designated beneficiary. We’ll focus primarily on 529b plans in this article.

Making the most of 529b plan tax advantages.

Here are some simple strategies you can use to get the most out of your 529b plan contributions:

  • Maximize contributions and reduce your taxable income by investing up to your plan’s annual limit (check the details of your plan for the specific amount).

  • If the beneficiary of your 529b plan receives scholarship funds, they can be deposited into the 529 account. You can then withdraw funds to pay for qualified expenses without having to pay the 10 percent tax penalty.

  • If the plan beneficiary receives a full scholarship and the funds are not needed, 529 plan proceeds can still be used for advanced degrees, qualified room-and-board expenses, or transferred to another beneficiary.

  • For relatives who may wish to help fund a 529 plan for your child, contributions of $14,000 a year or less qualify for the annual federal gift tax exclusion.

  • You can also gift a lump sum of up to $70,000 ($140,000 for joint gifts) and avoid federal gift tax, provided you elect to spread the gift evenly over five years.

Know the rules for using 529 plan proceeds.

Investment income from a 529 plan can be withdrawn with no tax penalty if it is used to pay for qualified education expenses for the plan’s designated beneficiary. These qualified expenses usually encompass tuition, education related fees, books, school supplies, and equipment required for enrollment or attendance at an eligible educational institution. 529 plan proceeds may also be used for room and board expenses for students attending college on at least a half-time schedule. Like all tax deductions, the IRS demands proof that you are using withdrawals from your 529 plan for eligible expenses, otherwise you could face penalties for making a nonqualified withdrawal. Penalties generally include the earnings portion of your withdrawal being subject to federal income tax assessed at the account owner’s rate (not at the beneficiary’s tax rate). In addition, any earnings used for ineligible expenses will be subject to a 10 percent federal tax penalty and potentially a state tax penalty as well.

Good news! 529 plans offer flexibility.

It’s a fact of life…sometimes plans change, and the good news is that your 529 plan can adapt, too. If the 529 plan beneficiary does not use the funds, you can change the plan beneficiary to another family member who is going to pursue college—such as a sibling, first cousin, grandparent, aunt, uncle or even a parent. Plan proceeds can be used for a range of degree options such as a four-year bachelor’s degree, a two-year associate’s degree, or certificates from a trade or vocational school.

Given their significant tax benefits, 529 plans are an attractive option for college saving. Our firm can help you determine if they are a good option for you, so please contact us for more information.

Source: Advantage Magazine September-October 2016. 

Photo Credit: Photo by pan xiaozhen on Unsplash

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