What You Need to Know About 529 Savings Plans.
“An investment in knowledge pays the best interest.”
– benjamin franklin
By Shawn Perkins | Financial Planning
6 minute read
Here we are at the end of May. It’s hot. Barbeques are getting fired up. Pool days, lake days, and beach days are back. Summer is here (unofficially, but you get it).
Today, May 29th, holds a special place in the world of financial planning. Today is 529 day!
No, not just 5/29, but 529. The college savings plan. To celebrate, let’s talk about the ins and outs of these accounts, and how to best use them for your own college planning purposes.
What are 529’s?
Named after Section 529 of the tax code, Qualified Tuition Plans, or more informally known as 529 plans, were set up to allow individuals to contribute to and invest in an account designated to be used for educational expenses, tax-free.
How much can I contribute to a 529?
Unlike 401(k)s and Individual Retirement Accounts (IRAs), there aren’t specific contribution limits set by the IRS. Instead, these limits are set by each individual state generally ranging between $200,000 to over $500,000 per beneficiary.
Virginia’s contribution limit for 2024 is $550,000. Realistically, this isn’t going to be an issue for most people.
That being said, contributions to 529’s are treated as a gift to the respective beneficiary. And there are limits to how much you can give a person each year without having to file a gift tax return. In 2024, the maximum that you give someone is $18,000 or $36,000 if you’re married ($18,000 each). This limit applies to each recipient, meaning you can give to multiple people up to the annual limit without having to file a gift tax return per year.
There is a special allowance for 529’s that allow contributors to superfund, or frontload, their contributions. You are allowed to contribute up to 5 years’ worth of the annual gift tax exemption, in this case $90,000, or $180,000 if married, to a 529 all at once. After doing this, you will not be able to make another contribution to the 529 for 5 years, and you will have to file a gift tax return in each of the next 5 years.
Do I receive any tax benefits for contributing?
Yes! While you don’t receive a deduction at the federal level, the proceeds from 529’s are tax-free if used for qualified education expenses. Meaning, the growth of your contributions can be sold and used for education expenses rather counting as income to you.
Some states allow deductions on your state tax return.
Virginia, for example, allows up to a $4,000 state tax deduction per account per year for 529 contributions. And, if you’re over age 70, you may deduct your entire contribution per account per year.
What do I do after I contribute?
One great advantage of 529 contributions is that they can be invested into investment funds that have the potential to grow over time. You will have different investment options to choose from depending on how aggressive or how conservative you want to be.
If you’re the set it and forget type, one strategy is to simply invest your contributions into a target date fund that corresponds to your child’s year of going to college. For example, if your child was born in 2023, you can invest in the 2040 fund (or something close to it). This will allow your contributions to participate in market growth over the next 18 years and will automatically become more conservative as college approaches.
Always keep in mind that investment comes with the risk that your contributions could lose value.
Can I use funds in my child’s 529 for educational expenses before college?
Yes! You can use up to $10,000 per year for K-12 expenses.
What if I use these funds for something besides education?
Non-qualified distributions made from a 529 will count as ordinary income for that year and will incur a 10% penalty. This penalty only applies to the growth on the contributions.
Will 529’s impact financial aid?
Yes. Parent owned 529’s will be counted as an asset for the parent and will reduce financial aid, but only by 5.64% of the 529’s value. In some cases, the 529’s value will not be counted at all if the parent makes below a certain amount of income.
What can I expect after I take money out of the 529?
First, make sure you keep receipts from the expenses that qualify as educational expenses. Here is further guidance on qualified expenses: IRS: Qualified Education Expenses
The beneficiary of the 529 will also receive a 1099-Q from the 529 plan with the amount distributed.
Remember, qualified expenses are tax-free and therefore do not need to be reported on your tax return. However, if there are non-qualified distribution it is up to the 529 owner to determine the taxable portion.
What if my child doesn’t go to college or doesn’t use all the funds inside the 529?
If the beneficiary of the 529 decides not to go to college, but instead goes to a trade school to become a HVAC technician, a dental hygienist, an electrician or other qualifying career, the 529 funds can be used to pay for their schooling.
If there are funds remaining in the 529, you have a few options.
First, if you’re the owner of the 529 plan, you can change the beneficiary of the 529 to another member of the family. This could be your other children, a cousin, a future grandchild, or yourself. As long as the new recipient is a family member of the previous beneficiary, the funds can continue to grow and be used for the educational expenses of the new beneficiary.
Next, you can convert the 529 funds to the beneficiary’s Roth IRA. As a result of recent tax law changes starting in 2024, you can move up to $35,000 total from the 529 plan to the 529 beneficiary’s Roth IRA without penalty or taxes. In order to qualify, the 529 must have been open for at least 15 years, and the beneficiary must have earned income. The maximum annual amount that can be moved from the 529 to the Roth IRA is limited to same contribution limitations of a Roth IRA ($7,000, or $8,000 for individuals over age 50).
Lastly, you can withdraw funds from the 529 for other expenses, but you may incur penalties and taxes. Remember, these penalties and taxes are only on the earnings of the contributions. There are ways around the 10% penalty. For example, if your student received a scholarship to their school, you may take out the amount of the scholarship from the 529 with incurring the 10% penalty. The earnings on the distribution will still be treated as ordinary income.
Are 529 plans right for you, or have further questions? Please reach out! Let’s set up a plan that’s right for you and your family.
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