57% of parents save for college, but most of that money is held in general savings accounts, not in tax-advantaged educational savings vehicles.
Not everyone is in a position to set aside money for the next generation without jeopardizing their own goals. But if you are fortunate enough to do so, or can start early and save over time, it is worth looking into your options.
Specialized savings accounts, informally referred to as 529s, should be at the top of your list because they offer preferential income and/or estate tax treatment. Here are a few advantages that 529s potentially provide for parents and grandparents to consider.
Capitalize on Federal and State Tax Savings
Assets contributed to a 529 on behalf of your designated beneficiary grow tax-free. Even better, the withdrawals are tax-free as long as they’re used for a qualified education expense, such as tuition, room and board and supplies mandatory for student courses. Most 529s are state-sponsored, which could provide additional tax savings. For example, some states, like Pennsylvania, allow a state income-tax break if one contributes to any 529 plan in any state. Other states (only) offer a tax benefit to residents who invest in their own state’s plan. It’s important to understand which tax deductions or tax credits may be available — especially if you reside in a state with income tax.
Take Advantage of Built-in Flexibility
Many worry that gifting large chunks of money to a 529 means they’ll irrevocably relinquish control of those assets. The good news is that 529s allow quite a bit of control, especially if you title the account in your name. Contributing to a 529 gets money out of your estate, but at any point, you can get your money back. Of course, that means it becomes part of your taxable estate again, subject to your nominal federal tax rate. Generally, when the 529 is not “used” as intended, such as brought back into your estate or not used for your designated beneficiary’s qualified higher education expenses, you pay an additional 10% penalty on the earnings portion of that withdrawal.
What if Your Beneficiary Receives a Scholarship or Financial Aid?
You’ve got options here, too. If you are the 529 plan account owner
- You can earmark the money for other types of education, such as graduate school.
- You may change the beneficiary to a different, qualifying family member of the current beneficiary at any time without tax or penalty. You can change the beneficiary as many times as you like since most 529s have no time limits or age limits for the beneficiary.
- You can take the money and pay taxes on any gains. Normally, you’d expect to pay a penalty on the earnings, too. But that’s not the case for scholarships. The penalty is waived on amounts equal to the scholarship as long as they’re withdrawn the same year the scholarship is received.
- Of course, you can always use the funds to pay for other qualified education expenses, like room and board, books and supplies needed for classes.
Bypass Gift Taxes for Five Years
A grandparent, or anyone really, can contribute up to $17,000 a year per person ($34,000 if married and filing jointly, for 2023) with no gift tax consequences. Better yet, if you can swing it, you can ‘super fund’ your 529 using the five-year accelerated gift election, a lump sum gift of $85,000 per contributor ($170,000 for married couples). The catch here is that you can’t make additional gifts for the next five years, but your larger gift now has the opportunity to compound tax-free over a longer time.
Give Generously
It doesn’t matter how much you make; you can contribute to a 529 for anyone of any age, including yourself if you plan to go back to school. There are no yearly contribution limits. However, there are maximum lifetime limits that you should understand, and those vary by state. Typically, each account can receive about $235,000 in lifetime contributions from all sources.
And… New 529 Plan Rules Can Help with Retirement Planning
Lastly, starting in 2024, 529 account owners will have the option to use excess 529 plan funds to jumpstart the retirement for their beneficiaries. Owners will be allowed to move unused funds in the account directly to the plan beneficiary’s Roth IRA. Note that 529 accounts must have been maintained for a minimum of 15 years to be eligible for this transfer.
Saving for college doesn’t have to be daunting; just disciplined. It helps to take advantage of investment vehicles designed to help. Keep 529 accounts in mind along your journey.
Tom King CFP®, CLU®, AEP® is Registered Principal of King Financial Partners goKFP.com at 222 Blue Course Drive, State College, PA. King Financial is a team of credentialed professionals specializing in retirement, investment management, wealth transfer, and estate planning. Tom can be reached at Tom@goKFP.com (814) 234-3300.
Investors should carefully consider the investment objectives, risks, charges and expenses associated with 529 college savings plans before investing. More information about 529 college savings plans is available in the issuer’s official statement. The official statement is available through your financial advisor and should be read carefully before investing. Before investing, It is important to consider whether the investor’s or designated beneficiary’s home state offers any state tax or other benefits that are only available for investments in such state’s qualified tuition program.
As with other investments, there are generally fees and expenses associated with participation in a 529 plan. There is also a risk that these plans may lose money or not perform well enough to cover college costs as anticipated. Tax implications can vary significantly from state to state. Withdrawals from 529 accounts that are not used for qualified education expenses are subject to taxes and penalties.
As a result of the SECURE ACT 2.0, unused funds in a 529 account can be rolled over to a ROTH IRA for the beneficiary. The 529 account must have been open for a minimum of 15 years and Contributions made to the 529 plan in the last five years, including the associated earnings, are ineligible for a tax-free transfer. Rollovers to a ROTH IRA are subject to the standard annual ROTH IRA contribution limits.
Sources: The College Board, savingforcollege.com, kitces.com, forbes.com, Worthwhile Spring 2017
Securities offered through Raymond James Financial Services, Inc., member FINRA/SIPC.© 2021 Raymond James Financial Services, Inc., member FINRA/SIPC. Investment advisory services offered through Raymond James Financial Services Advisors, Inc. King Financial Partners is not a registered broker/dealer and is independent of Raymond James Financial Services.
