Over the past few years, 529 plans are one of the premier methods of saving for college because of their high contribution limits, potential state income tax deductions on contributions, federal tax-free withdrawals for qualifying education expenses, and tax-deferred growth on investments. Notably, starting in 2024, The SECURE 2.0 Act has a provision that allows you to rollover unused 529 assets to a Roth IRA as an additional benefit. Below is a comprehensive overview of the features and benefits of 529 plans.
Qualified Expenses
Contributions may be withdrawn tax-free when used for qualified higher education expenses, including tuition, room and board, fees, books, supplies, and equipment, including computers. Keep in mind that 529 accounts can be applied for graduate school, medical school, and law school.
Additionally, up to $10K per year may be withdrawn for qualified elementary and secondary education expenses. This is a federal qualified withdrawal and not subject to federal income tax. Qualified elementary and secondary education withdrawals in states with state income tax may be added back to your state income tax if you previously claimed a deduction. Withdrawing for elementary and secondary education is not generally our advice. We believe maintaining more money in a 529 allows earnings to compound on more money over a longer time frame.
State Tax Benefits
Some states offer a tax deduction for a portion of the contribution amount (up to a set limit). Please note that California and Texas do not currently offer state-level incentive tax benefits.
Financial Aid
Funds in a 529 plan are treated as an asset of the parents, regardless of whether they are owned by the parent or the child. If the child is not a dependent, however, then the account will be treated as an asset of the child. Third-party 529 accounts, such as those owned by grandparents or other family members, have more of an impact on financial aid eligibility. The assets held in a grandparent-owned 529 account won’t initially be included in the student’s FAFSA calculations. But any withdrawals made to pay for their college expenses will count toward the student’s income, which is assessed at 50%. Therefore, it’s recommended that 529 plans owned by grandparents are distributed in the final years of college to avoid aid reduction in a subsequent year.
Contribution Limits
Individuals can contribute up to $18,000 per year ($36,000 for married filing jointly) per beneficiary to a 529 college savings account without filing a gift-tax return.
You can accelerate gifting by contributing up to five years’ worth of annual gifts into one year ($90K per individual, $180K for a couple in 2024) without using your lifetime gift and estate tax exemption. Be sure to report contributions between $18K-$90K on IRS Form 709 for each of the five years and check mark that the contribution is being spread evenly over five years. Contributing earlier on allows earnings to be compounded on more money over a longer time frame. Each state has its own 529 plan aggregate contribution limit (up to $550,000). In some states, super funding a 529 makes you ineligible for state tax credits. Be sure to discuss the pros and cons of super funding with your tax advisor.
Funding
Often, we advise funding 529 accounts up to 75% of the projected cost of college. We recommend not fully funding 529 accounts in case the beneficiary receives a scholarship. Nonqualified withdrawals are subject to taxes and a 10% penalty on the taxable portion of the withdrawal. If a beneficiary receives a scholarship, you can withdraw up to the amount of the scholarship and use the money for any purpose, penalty-free. However, the earnings portion is still subject to income tax.
Flexibility
Starting in 2024, 529 account holders can roll over unused 529 assets to a Roth IRA without penalty or tax provided certain rules are met. For example, the lifetime rollover limit is $35,000, the yearly contribution cannot exceed annual Roth IRA contributions, and the plan must be under the beneficiary’s name for 15 years. Speak with your tax advisor about additional rules and considerations.
Additionally, unused funds can be transferred to any family member of the beneficiary. The IRS provides a broad definition of family member. Keep in mind, changing beneficiaries can result in gift tax and Generation-Skipping Transfer Tax.
Funds may remain in a 529 for an indefinite period. If the funds are not ultimately used for eligible educational expenses, then any growth in the account is taxed as ordinary income and is subject to a 10% penalty.
Estate Planning
Remember to name a successor owner for your 529 plan. Naming successor owners allows that person to manage the 529 accounts upon your death or disability. While 529 accounts are not subject to federal estate tax, 529 accounts may be subject to state estate tax and or state inheritance tax depending on the state. Speak with your tax advisor.
While 529 accounts are one of the leading ways to save for college, there are a multitude of solutions. Read our Saving for Education whitepaper for additional methods to consider. Your Callan Capital team is available to answer any questions and to help you set up a 529 account or any other college savings account.
Disclaimer:
The information provided is for informational purposes only and should not be considered investment advice. There is a risk of loss from investments in securities, including the risk of loss of principal. The information contained herein reflects Callan Capital’s views as of the date of distribution. Such views are subject to change at any time without notice due to changes in market or economic conditions and may not necessarily come to pass. Callan Capital does not provide tax or legal advice. To the extent that any material herein concerns tax or legal matters, such information is not intended to be solely relied upon nor used for the purpose of making tax and/or legal decisions without first seeking independent advice from a tax and/or legal professional. Any forward-looking statements or forecasts are based on assumptions and actual results are expected to vary from any such statements or forecasts. No reliance should be placed on any such statements or forecasts when making any investment decision. Callan Capital is not responsible for the consequences of any decisions or actions taken as a result of the information provided in this presentation and does not warrant or guarantee the accuracy or completeness of this information. No part of this material may be (i) copied, photocopied, or duplicated in any form, by any means, or (ii) redistributed without the prior written consent of Callan Capital. For detailed information about our services and fees, please read our Form ADV Part 2A, and our Form CRS which can be found at https://www.advisorinfo.sec.gov, or you can call us and request a copy at (866) 912-4888.