Why You Should Consider Opening a 529 Account
Widely Used & Accessible
For many American families 529 college savings plans are an excellent way to grow funds for their children’s higher education and get a tax break along the way. This Federal program has become extremely popular, holding more than an estimated $400bb with about 16mm families participating. Almost every large asset custodian such as JP Morgan, Schwab, Vanguard and Fidelity offers a simple web-based means to open and manage these accounts. You then have many standard investment fund options to pick from.
Main Advantage
Investment returns earned inside a 529 incur no taxes and withdrawals for designated college expenses are not taxed either. In addition, many states, though not the federal government, allow the deduction of contributions when calculating taxable income.
Key Drawbacks
Once funds are placed into a 529 plan, a “non-qualified” withdrawal will trigger a payment of taxes on any income and appreciation plus a 10% federal tax penalty and possibly additional state penalties. Broadly speaking, you should only contribute funds you don’t plan to use for anything but higher education, though there are some important exceptions (see below for one of them). In addition, funds inside a 529 account may reduce the amount of financial aid a student is eligible for, depending on rules at each institution.
How Much Can I Contribute?
To avoid incurring gift taxes, standard yearly contributions to a single beneficiary must stay under $18,000 from an individual or $36,000 from a married couple. However, there is a ‘five year lump sum rule’ that accelerates funding, enabling up to $180,000 in an immediate, tax contribution by a married couple.
Additional Advantages
*Easy changes of ownership and beneficiary
In general, the owner of a 529 can transfer ownership to another family member. For example, a parent could switch ownership to a spouse or to an adult child. Moreover, while a 529 plan only has a single beneficiary at any given time, you can change the individual easily or roll over excess funds from one 529 account to another, for example, between siblings.
*Plans not part of owner assets
In most situations, 529 plans are not considered part of an owner’s personal wealth or estate. They are, thus, in most circumstances shielded from any legal action against the owner and do not incur estate taxes.
*$10k Yearly Tuition Payment at K-12 Schools
Due to a change in federal rules, funds in 529 accounts are now eligible to be used to educate younger beneficiaries. However, individual state rules may limit the advantages from these withdrawals.
Further Information
As with all federal programs, 529 plans are governed by a fairly complex set of rules as outlined by the IRS. Each state sponsor also establishes its own guidelines. Before moving ahead, it is important to consult the details of both IRS regulations and the individual state plan you are choosing. You can opt to use any state program no matter where you live or where the beneficiary intends to go to college. There are usually extra tax advantages to using the program from the state where you reside.
Written By David L. Frank, CFA
The information provided in this article is for informational purposes only and does not constitute financial advice. While the insights and opinions expressed are based on professional experience and current market knowledge, they are not a guarantee of future performance. Readers should consult with a qualified financial advisor to discuss their specific investment needs and objectives before making any investment decisions. The information contained in this article has not been filed with, reviewed by or approved by the SEC or any other United States regulatory or self-regulatory authority.