5-2-9 Day

May 28, 2021

By Theresa Cagle Fry, Senior Vice President and Manager, IRA’s and Retirement Planning

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In the world of finances, May 29 has become synonymous with education planning and saving for college. Why? One the most helpful ways to save for a child or grandchild’s education is through a 529 savings plan.

What is a 529 Education Savings Plan?

A 529 Savings Plan is an education savings plan that is designed to provide tax-advantaged savings for future education costs, specifically for K-12 tuition expenses at public, private and religious schools along with a variety of qualified expenses at colleges, universities, trade schools, or other post-secondary education institutions. The plans are sponsored by states and may be offered either directly or through a financial advisor. The unusual name they have is because when they were created, they were added to the Internal Revenue Code in Section 529.

What are the tax advantages of a 529 Education Savings Plan?

For purposes of your federal income taxes, contributions you make are not income tax deductible, but the savings in a 529 plan grow tax deferred. By not being taxed on the earnings as the account grows, 529 savings plans provide an advantage over saving in your checking, saving, or taxable investment accounts. And as long as the withdrawals are used for qualified education expenses, they are income tax free.

Qualified withdrawals include tuition and fees, books and supplies required for enrollment and attendance, and room and board costs – although there are limits on room and board if the student is living off campus or is not at least a part-time student. In addition, 529 savings plans can also be used for registered apprenticeship programs and for repayment of up to $10,000 in outstanding student loans for both the student and siblings of the student. For K-12 students, only tuition is covered (up to $10,000 per year).

Depending on your state of residence, you may be able to receive a state income tax deduction or credit for the contributions you make. Most states offer the income tax deduction or credit only if you contribute to your home state’s 529 savings plan, however, there are a few states that provide it regardless of which state’s plan you elect to use. In addition, how a state defines qualified education expenses may be different. Not all states will recognize K-12 tuition, registered apprenticeship programs or student loan repayments as a qualified withdrawal.

What if the student doesn’t go to college?

The good news is that 529 savings plans aren’t just for college anymore. Because they can be used for elementary and high school tuition, trade schools such as culinary school or cosmetology  school, and for registered apprenticeship programs, students that decide not to pursue a traditional four-year degree program at a college or university can still benefit. Apprenticeship programs are available in a variety of industries such as manufacturing, construction, and healthcare. In addition, amounts you have saved in a 529 education savings plan for one student can also be used tax-free by other members of the family by changing the name of the beneficiary on the account.

However, if the savings in a 529 plan are withdrawn and not used for qualified education expenses, any earnings that have accumulated are treated as income on your federal income tax return and are also subject to a 10% penalty. In addition, if you received a state income tax deduction or credit when you made the contribution to the plan, a non-qualified withdrawal will generally cause the state to “recapture” the tax benefit they provided to you earlier.

How much money does it take to get a 529 Education Savings Plan started?

There is no minimum contribution amount required to start a 529 education savings plan.  Contributions are considered gifts and are subject to the $15,000 annual gift limit. A married couple, for example, could contribute $15,000 from each spouse to the same student, bringing the total up to $30,000. One unique feature of a 529 education savings plan is a special rule that allows you to advance up to five years of annual gifts. If you want to jump start education savings, you can make a one-time gift of $75,000 (or $150,000 for a married couple), but then you must forgo any additional gifting to that student for the next five years.

Give Your Loved One the Gift of Education

The month of May is also traditionally associated with graduations and new beginnings for students. It is a perfect reminder of how important a good education is in today’s world and how important it is to plan for that educational expense. Don’t leave yourself vulnerable, scrambling to figure out a plan to pay for your loved one’s education. Or worse, be forced to spend down your retirement savings or accumulate a lot of debt through loans to put your child or grandchild through college. Instead, consider investing in their future education while they are young. Talk to your financial advisor about your options for saving for – and funding – this very important goal.

Benjamin F. Edwards does not provide tax advice; therefore, it is also important to consult with your tax professional for additional guidance tailored to your specific situation.