Is a 529 Plan Right for You? Tax and Estate Benefits Are Amplified for Certain Income Brackets

Many grandparents and parents want to pay for private school or college for children or grandchildren. With significant tax benefits, a 529 plan may be your best option, particularly if you are wealthy.

What is a 529 Plan?

A 529 plan is a tax-advantaged savings plan designed to help individuals and families save for future education expenses. It is named after Section 529 of the Internal Revenue Code, which governs these types of plans.

It is kind of like a Roth 401k or IRA, except that instead of getting tax advantages for saving for retirement, you get tax advantages for saving money for educational expenses.

How a 529 Plan Works

Anyone can set up a 529 account and name anyone as a beneficiary – including a child, grandchild, friend, or even yourself – and there is no limit to the number of plans you can set up.

For grandparents, you can either open your own 529 plan or can contribute to a 529 plan that the parents of the child have opened.

Money in a 529 plan is invested post tax, but the savings grow tax free and all distributions are tax free.

These plans, also known as “qualified tuition plans,” are sponsored by states, state agencies, or educational institutions that are authorized. You can find and compare plans at the College Savings Plan Network.

Let’s Explore Some of the Advantages of 529 Plans

The Definition of Education Costs is Fairly Flexible

529 plans are not just for college. You can use up to $10,000 a year for elementary, middle, or high school as well as two-year associate degree programs, trade schools, and vocational schools—both at home and abroad. $10,000 can also be used to pay off existing student loans.

And, 529 funds can be used for tuition, books, technology needed for school, and even room and board associated with college costs – up to a limit.

Room and board expense can be up to the school’s estimate for living expenses for nine months out of the year.

Student health insurance, even if offered by the university, can not be funded with the 529.

The Beneficiary Can Be Switched

529 plans offer flexibility in terms of the choice of beneficiary. If the original beneficiary doesn’t use all or part of the funds, the account owner can change the beneficiary to another eligible family member without incurring taxes or penalties.

NOTE: There are limitations to how frequently changes can be made. Some plans allow only one beneficiary change per year or require specific qualifying events for changes to be made.

There Are Tax Advantages to 529 Plans

Tax advantages are one of the biggest benefits of a 529 plan. The investment growth within the plan is tax-free as long as the funds are used for qualified education expenses. This tax-free growth can result in significant savings over time.

Many states offer additional tax benefits for contributions made to a 529 plan. These benefits can include deductions or credits on state income taxes, potentially reducing the overall tax burden.

Also Estate Planning Benefits

All contributions and earnings into a 529 plan will grow outside of your taxable estate. And, you retain control over the account.

You Retain Control Over Funds

As stated above, the account owner retains control over the money in a 529 account, even after the beneficiary reaches the age of majority. This control ensures that the funds are used for their intended purpose.

You Now Have Options if Funds Are Not Needed for Education

Starting on Jan. 1, 2024, up to $35,000 of leftover funds in a 529 account can be rolled over into a Roth IRA account, if the fund is at least 15 years old.

Downsides of 529 Plans

The Already Wealthy Benefit the Most from 529s

According to research from the Brookings Institution, the benefits of 529s are relatively small for all but the wealthiest families.

Possible Impact on Financial Aid (It Is Complicated)

A 529 plan can impact financial aid, but there are a lot of complicated caveats.

Whether or not 529 funds will reduce a financial aid package depends largely on who owns the account. Here are some considerations:

• If the 529 is owned by the parent or the student, then around the first $10,000 won’t be counted in the FAFSA aid calculation.
• For parents who have saved more than the allowance, only a maximum of 5.64% of parental assets are counted whereas 20% of student assets are counted.
• Distributions from accounts owned by parents or students are not included in the “base-year income” that would reduce financial aid eligibility.
• Assets owned by a grandparent or any other relative will have no effect on the student’s FAFSA. However, distributions from a grandparent’s account are counted as student income on the FAFSA. This income is assessed at 50% which means that if a grandparent funds $5,000 of costs, it could reduce the student’s eligibility for aid by $2,500.

NOTES:

The FAFSA looks at income from two years prior, so if it otherwise makes sense, a grandparent may want to wait to fund junior and senior year of college to avoid impacting financial aid.

Starting with the 2023-24 school year, grandparent owned 529 plans will have less impact on financial aid eligibility with the simplified FAFSA.

It’s Important to Fund Your Own Retirement BEFORE Funding a Child’s Education

There is tremendous gratification to be gained from helping to shape another generation. Part of this gratification comes from helping grandkids pursue educational goals, including attending college.

“We find a lot of parents and grandparents feeling some sort of emotional obligation to pay for college, and they’ll do that at the expense of their own retirement,” says Sarah Swantner, a certified financial planner with Kahler Financial Group in Rapid City, South Dakota.

But spending significant amounts on children’s or grandchildren’s education can derail retirement plans and leave older adults with more problems to deal with.

“They could actually be doing more harm than good,” says certified financial planner Debbra Dillon, of Eagle, Idaho-based Dillon Financial Planning. “Eventually, down the line, if they don’t have millions of dollars in their accounts to support retirement and college, they’re going to end up putting their kids in the position of having to take care of them [financially].”

Limited Usage

Although there is a degree of flexibility built into 529 plans and some funds can now be transferred to retirement accounts, this money is intended to be used for education.

If the funds are used for non-qualified expenses, they may be subject to taxes and penalties.

Fees

529 plans may have administrative fees, management fees, and other charges that can affect the overall returns. It’s important to review and compare the fees associated with different plans.

Additional Facts About 529s

There Are Contribution Limits

There are no contribution limits for 529 plans. However, contributions to these accounts are considered gifts for federal tax purposes and 2023 contributions in excess of the annual gift tax exclusion ($17,000) will count against your lifetime estate and gift tax exemption. 

This means a couple can give twice this amount jointly in 2023, or $34,000, since there are two individuals doing the giving.

You also have the option of making a lump sum contribution. You could contribute $85,000 (the equivalent of $17,000 a year over 5 years) at one time as long as no other gifts are made to the same beneficiary over the next 5 years.

Each state also has an aggregate contribution limit for 529 plans. The total amount that can be contributed for each beneficiary may not exceed certain limits. These limits range from $235,000 to $550,000. (The limit is based on the price of attending an expensive college and graduate school program, including textbooks and room and board.)   

A Range of Investment Options Are Typically Available

Most 529 plans offer a variety of investment options, such as mutual funds or age-based portfolios. This allows account owners to choose an investment strategy that aligns with their risk tolerance and time horizon.

However, your investment options in a 529 plan are likely more limited compared to other investment vehicles.

A 529 Prepaid Tuition Plan Locks in College Costs

If the beneficiary will attend a public school in your state (or one of a consortium of private schools), you may be able to prepay tuition using 529 funds. Prepaying guarantees that today’s tuition costs are locked in. You aren’t paying additional money as tuition increases each year.

Evaluating Options with a Financial Advisor May Benefit You

Because these accounts are complicated, you may want to consult with your financial advisor or a tax specialist.

Does a 529 Plan Make Sense for You?

First things first. You will want to know how a 529 account might impact your retirement finances and long term plan for wealth and security. Use the Boldin Retirement Planner to figure out whether or not you have the wherewithal to afford funding education costs.

You can also use the tool to model the impact of a 529 plan on your finances. Create and model contributions to this account type and see tax implications. Boldin offers the most comprehensive set of tools to help you achieve long term wealth and security.