Not Your Average 529 Plan - Education Planning, Part 1

So, let’s start with a refresher. What is a 529 college savings plan (spoiler alert: no longer just college)? 

A 529 plan is a tax-deferred account with contributions invested in a selection of mutual funds or exchange-traded funds. Later, those assets can be withdrawn tax free if used for qualified expenses. These contributions are not deductible on your federal tax return, but many states offer a state tax deduction for contributions made to 529 plans. And yes, Pennsylvania is one of those states!

How Much to Contribute

  • The IRS allows for an annual gift tax exclusion of up to $15,000 per recipient for individuals ($30,000 for married couples) annually without gift-tax consequences.

  • Under a special election, accelerated gifting is allowed with a one-time gift to a 529 plan of up to $75,000 per recipient for individuals ($150,000 for married couples), to be contributed and prorated over five years — without incurring federal gift tax or using the donor’s lifetime gift tax exclusion.

Defining a Qualified Expense

It’s important to know, “What is considered a qualified expense?” Withdrawals from 529 plans to fund qualified expenses are tax free. With the 2018 Tax Cuts and Jobs Act, the answer to this question has changed. Let’s take a closer look.

Traditionally, qualified expenses were those incurred at an eligible postsecondary school. These included the following: 

  • Tuition, fees, books, supplies, and equipment

  • Room and board that is included in the cost of attendance

  • The purchase of computer or peripheral equipment, computer software, or Internet access and related services used primarily by the student during any of the years he or she is enrolled at an eligible postsecondary school

Under the new act, however, qualified expenses have been expanded to also include expenses incurred at an eligible elementary or secondary school. These K-12 expenses are at capped at $10,000 in tuition per designated beneficiary during a tax year.

The State Tax Deduction Loophole

The state tax deduction for contributions may provide incentive to put money into a 529 account and then take it right back out. Why? In theory, you could put money in a 529 account, get a state tax deduction, and then take that money right back out to pay for qualified expenses. With the new tax act, this loophole is especially helpful since funds can also be used for elementary and high school education. Some of the states that do offer the deduction are not happy about this “loophole,” fearing it will reduce revenue. So, don’t be surprised if you see changes to these rules in the future.

A Closer Look at 529 ABLE Accounts

Lesser known 529 ABLE (Achieve a Better Life Experience) accounts were established in 2014 to allow disabled beneficiaries (or their families) to save in a tax-deferred account. These accounts do not count as an asset for state or federal aid eligibility until they exceed $100,000. Some states also offer state tax deductions for contributions up to certain limits.[DF1]  And again, PA is one of those states!

The tax act has opened up the ability to roll over up to the annual gift limit amount ($15,000 for 2018) from an existing 529 account into a 529 ABLE account for the same beneficiary. This is great news for parents of children with disabilities who previously opened traditional 529 plans for those children. The existing 529 plans will count against any state or federal benefits, and many of these children won’t incur the qualified expenses of the traditional 529 plan. The new rollover provision will allow them to start transitioning those accounts over from 529s to 529 ABLEs. Although this process may take a few years, it will help them avoid the current scenario of taking taxable nonqualified withdrawals and making new contributions.

The definition of qualified disability expenses is much more flexible for the 529 ABLE account. These expenses can include the following: 

  • Education

  • Job training and support

  • Health care

  • Housing

  • Financial management

Want to know more?

Read Part 2 of Marianna’s review of 529 plans: Not Your Average 529 Plan – Retirement and Estate Planning, Part 2. This article will explain how 529 plans can be used for other planning goals such as retirement, estate planning and multi-generational wealth transfer. 

Marianna Goldenberg, CDFA® is a financial consultant with CURO Wealth Management at 1705 Newtown - Langhorne Road Suite 5, Langhorne, PA 19047. She offers securities as a registered representative of Commonwealth Financial Network®, Member FINRA/SIPC. A registered Investment Adviser. She can be reached at 215.486-8350 or at marianna@curowm.com.

The fees, expenses, and features of 529 plans can vary from state to state. 529 plans involve investment risk, including the possible loss of funds. There is no guarantee that a college-funding goal will be met. In order to be federally tax-free, earnings must be used to pay for qualified higher education expenses. The earnings portion of a nonqualified withdrawal will be subject to ordinary income tax at the recipient’s marginal rate and subject to a 10-percent penalty. By investing in a plan outside your state of residence, you may lose any state tax benefits. 529 plans are subject to enrollment, maintenance, and administration/management fees and expenses.

Marianna Goldenberg, CDFA™Comment