By Theresa Cagle Fry, Senior Vice President and Manager IRAs, Retirement & Education Planning
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Summer is unofficially here! Schools are wrapping up the academic year and summer vacations are beginning. Looking forward to a new school year may be the last thing on your mind as you wrap up this one, but that is where National 529 Day steps in.
National 529 Day is recognized on May 29 as a way to bring awareness to the value of planning and saving strategically for future education expenses. Section 529 of the Internal Revenue Code outlines the federal income tax advantages of saving when using “qualified tuition programs,” which is why they are commonly referred to as “529 plans.” They can be an excellent way to provide tax-free benefits for future education expenses.
You can contribute to a 529 education savings plan using annual gifts, which you can make to any individual in amounts up to $19,000 this year; or alternatively, you can use a special advanced funding rule that allows up to five years of annual gifts to be made at one time. This increases the contribution amount to $95,000[i]. For married couples, both spouses can make gifts to the same student/beneficiary, doubling the amounts to $38,000 using an annual gift and $190,000 using the five-year advance gifting election.
Although there is no federal income tax deduction available for the contributions you make, investments grow tax-deferred, and if used for qualified education expenses, the withdrawals will be income tax free[ii]. When a student attends a college or university at least half-time, qualified education expenses generally include any expense that is required for enrollment or attendance such as:
- Tuition and fees
- Books and supplies
- Housing and food (also referred to as room and board)
- Repayment of student loan debt (up to $10,000) for the student or siblings of the student
However, 529 education savings plans are not just for college-bound students. They can also be used tax-free for K-12 tuition (up to $10,000 per year), for trade schools, or apprenticeship programs after high school. [iii]
529 savings plans are sponsored by states, and many will provide the contributor with a state income tax deduction or credit, which is typically contingent upon the contribution being made to the 529 plan that is offered by the state you reside in, although a few exceptions apply.
With a 529 education savings plan, you also have the flexibility to change a beneficiary, income tax free, to another eligible family member. For example, you could move all or part of the savings from your oldest child to a younger child or keep the savings in the 529 plan and in the future change the beneficiary to the current beneficiary’s children.
Long-term unused 529 education savings plan balances can also be used tax-free to fund a Roth IRA for the 529 plan beneficiary’s future retirement income. There are some requirements you have to meet to use this newest feature of a 529 plan:
- 15-Year Rule. Amounts eligible to fund a Roth IRA must be from a 529 savings plan that has been funded for at least 15 years.
- 5-Year rule. No contributions or earnings from the prior five years can be contributed to the Roth IRA.
- Earned Income and Annual Contribution Limits Apply. The Roth IRA beneficiary must have earned income (although the typical Roth IRA modified adjusted gross income limits do not apply), and the amount transferred to the Roth IRA cannot exceed the annual contribution limit (100% of earned income or $7,000, whichever is less).
- Lifetime Limit. The total amount transferred during the 529 savings plan beneficiary’s lifetime cannot exceed $35,000.
- Direct Transfer. The Roth IRA contribution must be made via a direct transfer from the 529 plan.
The tax advantages and flexibility of a 529 savings plan make it a more attractive alternative than using your personal or retirement savings. When you consider the average one-year undergraduate cost for the 2024-2025 academic year for tuition, fees, housing and food for attending a four-year public out-of-state college was $44,090 and $24,920 for an in-state four-year public school[iv], there is no better time to create a savings plan for your loved one’s education. Contact your financial advisor today for more information about 529 education savings plans.
As we kick off summer, Benjamin F. Edwards will begin its Summer Saving Strategies blog series providing you with valuable ideas each week. In addition to saving for education, we will cover a variety of ways you can save for your retirement and how to make the most of the tax advantages they offer, how to save more by minimizing taxes, some lesser-known money saving tips, and how you can balance protection and growth while investing your savings.
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[i] When making the election for advanced five-year gifting to fund a 529 education savings plan for the maximum amount, any additional gifts made to the student/beneficiary during the five-year period would be considered a taxable gift, unless the gift tax exemption increases. With the advanced gifting election, the gift is prorated over five years equally.
[ii] Withdrawals that are not used for qualified education expenses typically result in federal income taxes and a 10% penalty on the earnings portion of the withdrawal. Some exceptions to the penalty apply. Nonqualified withdrawals can also result in a recapture of state income tax benefits previously received.
[iii] Student loan repayments, K-12 tuition and registered apprentice program expenses, although recognized as qualified tax-free distributions for federal income tax purposes, may not be considered qualified distributions for your state income tax return. State nonqualified withdrawals can result in a recapture of the previously provided state tax deduction or credit.
[iv] The College Board, “Trends in College Pricing and Student Aid 2024”, Table CP-1.
The information provided is based on internal and external sources that are considered reliable; however, the accuracy of this information is not guaranteed. This piece is intended to provide accurate information regarding the subject matter discussed. It is made available with the understanding that Benjamin F. Edwards & Co. is not engaged in rendering legal, accounting or tax preparation services. Specific questions on taxes or legal matters as they relate to your individual situation should be directed to your tax or legal professional.