Five things you may not know about 529s (but should)
Morgan Stanley Wealth Management09/02/22
Summary: They're tax friendly, flexible, and available to anyone. Yet, 529 education savings plans are still underused. Here are five things that parents, grandparents, and anyone hoping to get a leg up on college costs need to know.
How are some families planning for future education expenses? According to Sallie Mae’s “How America Pays for College” 2021 report, 37% of families used a college savings account like a 529 to pay for college.1 A 529 plan can be used for more than just college savings. They’re tax-advantaged investment plans that can help families save for an array of educational costs.
For all their benefits, 529 plans are still often misunderstood and under-utilized. Here's what you may not know:
1. They offer considerable income tax benefits to the account owner
529 plans offer federal and state tax-free growth for as long as you’re invested within the plan—and there's never a required minimum distribution. Withdrawals for qualified educational expenses are federally tax-free and free of most states' income taxes. Further, some states offer various levels of income tax deductions or credits for contributions to one or more 529 plans to further encourage saving and investing.
The plans are state-sponsored, but you can participate in mostly any state's plan. However, consider your home state’s plan first as it may offer benefits exclusive to residents. Check with your tax advisor to see what your state may offer.
2. Anyone can be a beneficiary
There are no income or age limitations, and any adult can open an account for any person's future educational expenses. Account owners may change beneficiaries for any reason at any time. You can even name yourself as a beneficiary.
3. They can be used to cover a range of education-related expenses
Funds from a 529 plan may be used tax-free for tuition and certain expenses at many kinds of post-secondary institutions, such as art or cooking institutes, community colleges, trade and vocational schools, and eligible international school expenses. You may even be able to use 529 funds for up to $10,000 in elementary and high school tuition annually.2 Additionally, you can now use up to $10,000 to repay qualified student loans and cover certain costs for qualifying apprenticeship programs. Connect with your tax advisor to learn more about any state tax implications associated with covering these costs.
4. Grandparents, relatives, and friends can contribute
The lifetime account contribution limits are generous, ranging from $235,000 to over $500,000 per beneficiary.3 These are plan specific, so you should read the materials provided by your plan carefully.
Plus, 529 plans can serve as an estate planning tool. Anyone can contribute up to $16,000 per year ($32,000 for married couples) to any individual’s 529 plan, without triggering the gift tax.4 Additionally, they can bundle five years of contributions into one $80,000 contribution ($160,000 for married couples), provided they make the required election on a gift tax return for the year of the contribution.5
5. They have minimal impact on financial aid
The impact on financial aid is typically minimal for 529 savings plans. As long as a parent is the account custodian, the child's financial aid will decrease by no more than 5.64% of the account value.6
As previously mentioned, grandparents and other relatives can contribute to a parent's plan. If they set up their own 529 account, they can take advantage of state deductions where available and retain control of the account. But going this route may affect financial aid.
Invest for the future
With the costs of education trending higher each year, paying for college has become a major life expense that requires smart planning. A tax-advantaged strategy like a 529 plan is just one way to invest for the future.
The source of this article, Five Things You May Not Know About 529s (But Should), was originally published on June 21, 2022. The original content has been modified for E*TRADE from Morgan Stanley audiences.
- Sallie Mae, “How America Pays for College 2021”
- Assets can accumulate and be withdrawn federal income tax-free only if they are used to pay for qualified expenses. Qualified expenses include tuition, fees, room and board, books and supplies at virtually any accredited post-secondary school. Effective January 1, 2018, the definition of qualified education expenses expanded to include tuition for K-12 schools, as a result of the 2017 Tax Cuts and Jobs Act. The revised tax law limits qualified 529 withdrawals for eligible K-12 tuition to $10,000 per beneficiary per year and state tax treatment will vary on a state by state basis. The state tax treatment of K-12 withdrawals is under review by many states. Account owners should consult with a qualified tax advisor prior to making such withdrawals as they may be subject to adverse tax consequences. Earnings on non-qualified distributions will be subject to income tax and a 10% federal income tax penalty. Note, the Setting Every Community Up for Retirement Enhancement (SECURE) Act of 2019 signed into law December 20, 2019, expanded the definition of qualified higher education expenses for federal income tax purposes to include certain costs associated with qualifying apprenticeship programs and up to $10,000 (lifetime limit per individual) in amounts paid towards qualified student loans of the 529 plan designated beneficiary (or such beneficiary’s sibling). Note, however, using 529 plan distributions to repay qualified student loans may impact the deductible of student loan interest. This provision applies to 529 plan distributions made after December 31, 2018. The state tax treatment of 529 plans (including the state tax treatment of contributions and distributions) may be different from the federal tax treatment and may vary based on the particular 529 plan in which you participate and your state of residence. If the applicable state tax law does not conform with the federal tax law, 529 plan distributions used to pay certain expenses, such as principal and interest on qualified student loans and/or qualifying apprenticeship costs, may not be considered qualified expenses for state tax purposes and may result in adverse state tax consequences to the account owner or designated beneficiary.
- Maximum contribution limit varies by state.
- Morgan Stanley Global Investment Committee Special Report: 529 Plans: A Closer Look at a Versatile Solution, May 2021.
- This assumes that there are no accelerated gifts made by the gift-giver to the same beneficiary during the year of the accelerated gift or the prior four years. Any accelerated gifts made in any of the four years prior to an accelerated gift is made may result in a taxable gift. Any gifts made during the year of the accelerated gift or the four years after may also result in a taxable gift.
- Although the rules may vary slightly by state, generally, a 529 account owned by a parent for a dependent student is reported on the federal financial-aid application (FAFSA) as a parental asset and is assessed at a (maximum) 5.64% rate in determining the student’s expected family contribution. Source: Does a 529 Plan Affect Financial Aid?