Introduction to 529 plans
Reducing the impact of higher education expenses is on everyone’s mind. We see it everywhere: in reports that the cost of college has increased about 37% over the past 10 years, in the increasing national student loan debt load of 1.54 trillion dollars--the evidence goes on and on. It’s no newsflash; higher education is expensive.
Even in the face of ever-increasing expenses, governing bodies still see value in an educated populace. Though the price is steep, higher education benefits both the individual and their community, and therefore governments want to help and incentivize people to seek more education. One tool to incentivize education saving is an investment account that gives special tax breaks, the 529 plan.
Basics of 529 plans
Named after Section 529 of the Internal Revenue Code, 529 Plans (or Qualified Tuition Plans) let savers establish investment accounts where investment growth is tax-free if funds are used to cover Qualified Higher Education Expenses at an Eligible Educational Institution. These accounts have an owner who decides when the money is spent and a beneficiary whose expenses are paid with account funds. 529 plans are administered on a state-by-state basis and vary depending on the specific states’ tax law.
Most states that levy an income tax also allow a state tax deduction in the year that funds are deposited. Some states only offer this break when funds are invested in that state’s 529 plan, while others allow a tax deduction even if the funds go to another state’s plan.
What are 529 plans used for? Where can a 529 beneficiary use the funds?
529 plans’ Qualified Higher Education Expenses include but are not limited to costs such as:
-Tuition and related fees
-Room and board
-Books and computers
Students must be attending school at least half-time (as defined by the educational institution) to use 529 funds for qualifying expenses.
An Eligible Educational Institution is any college, university, trade school, or other post secondary educational institution eligible to participate in a student aid program run by the U.S. Department of Education. Recent legislation also includes certain registered apprenticeships and similar job training programs that are certified with the Secretary of Labor.
In certain states, up to $10,000 from 529 plans can be used each year (per beneficiary) to pay for student K-12 tuition at private schools. No fees other than tuition are considered qualified.
In addition, select states allow money from 529 plans to be used to pay off a lifetime maximum of $10,000 of qualifying student loan debt.
What if I put too much money in?
If the beneficiary decides to not attend school or the account is overfunded, you have a few options.
Change the account beneficiary
Beneficiary status is easily transferable to siblings and other relatives, so if not all the money is used by the original beneficiary, it can be used by another person.
2. Take the money out for nonqualified expenses and incur a penalty
If money is taken out for nonqualified expenses, the gains are taxed and have an additional 10% penalty applied.
3. Take the money out without penalty in case of a qualifying exclusion
There are some exceptions to the 10% penalty. Earnings on the investment are still taxable but the penalty is not assessed when money is withdrawn if the beneficiary passes away or becomes disabled, or if the beneficiary withdraws money because they received non-taxable scholarships or grants, employer-provided education assistance, etc.
Making use of 529 grant programs
Certain states offer dollar-for-dollar matching grants for 529 plan contributions made on behalf of an eligible individual. Colorado, for example, has a generous dollar-for-dollar match of up to $500 if you contribute it to the account of your dependent below the age of eight. A family of four is eligible for a matching grant if their income was below $104,800 in 2020.
Using 529 money in the same year it’s deposited
Most states allow you to put your money into a 529 plan and immediately withdraw it to cover qualified expenses while still receiving the state tax deduction. Effectively, this means that even if you haven’t saved in a 529 plan, you can still receive a tax deduction in the year you have eligible expenses.
Simply put, 529 plans are a valuable tool that can reduce the pain of paying for school. Though specifically intended for education expenses, they still offer you a lot of flexibility.
Interested in learning more? Always feel free to give us a call at (316) 768-7526, explore in-depth guidance in the IRS Publication 970, or contact your tax advisor.
Not intended to be tax or legal advice.