The buzz has been out there now for a little while but there is still a lot of confusion about 529 Plans when I speak to parents. As with anything relating to investments or potential tax savings, things aren’t always as clear as we would like them to be. And there are lots of people out there interpreting them in unique ways and then spreading this misinformation to others. Let me try and clear a few things up for you with regard to these mystical and advantageous 529 Plans.
Simple Definition and Resource
Simply put, 529 plans, otherwise known as “qualified tuition plans,” provide a tax-sheltered way of saving for education. That’s the simple explanation of what they were designed to do…help parents and students save for education in the future. These plans are sponsored by states, state agencies, and/or educational institutions. I strongly encourage you to review the College Savings Plan website for information on the 529 plans for all 50 states.
How They Work
There is generally a lot of confusion about the tax implications of these plan. For example, a contribution to a 529 plan is not federally income tax-deductible, though it may qualify for a state income tax deduction in some states. However, the assets in the plan may be invested in various ways, depending upon the particular plan you choose. Income earned in the 529 plan is currently not taxed. In fact, it may never be taxed, depending upon how it is distributed…this makes it potentially a great education and tax tool.
Distributions from 529 plans are income tax-free if they are used for the beneficiary’s qualified education expenses, which include tuition, books, and other education-related expenses for students at colleges, junior colleges, technical schools, and even at primary and secondary schools (under the 2018 tax law and approved in most states, up to $10,000 per year).
However, if things change and the distributions aren’t used for qualified education expenses, the earnings will be taxable and may be subject to a 10% penalty. So before you decide this is just a great place to park some money and avoid some taxes you might want to think again about that strategy.
Gift Tax annual Exclusion
Contributions to a 529 plan may qualify for the gift tax annual exclusion (currently $15,000 per year per person). In fact, an individual may utilize up to 5 years of annual exclusions up front in a single contribution! However, if the donor then dies within 5 years, the value of the annual exclusions for the years into which the donor did not survive would be brought back into the donor’s taxable estate. Even if this happens, any growth on the funds would be out of the donor’s taxable estate.
Typically, if a donor retains control over their assets, those assets are included in the donor’s taxable estate. What is unique about 529 plans is that the donor can keep control of the plan during his or her lifetime by being the owner of the plan and yet the assets in the plan are still removed from the donor’s taxable estate. Unlike other types of college savings plans, if the beneficiary does not want to pursue an education, the account owner can change the beneficiary designation…which can be a significant advantage to using a 529 plan.
If you are worried you might become incapacitated or pass away, you can name a contingent owner who would then be able to direct the plan. You can even designate a living trust to hold the 529 plan. However, if you do that, you would be limited to one annual $15,000 contribution per year.
Lots to Think About
As you can see, these 529 plans are a great concept and offer some incredible opportunities for helping young students with their education and get some tax advantages along the way. But there are sink holes along the way you want to watch out for and prepare for before you decide to create one and fund it. As with most of these plans, they are well designed for the purpose they are created…but when things go off course they can have some significant repercussions if not used as designed. They should definitely be investigated if you have children (or grandchildren) who you would like to help with educational costs.
What To Do Next
Everyone’s situation is unique and different with many nuances. If you’re uncertain about how these might affect your current situation or your situation in the future, see a competent financial advisor and an estate planning attorney. Both can help you with the investment and tax impacts 529 plans can have on you, your children, and your estate. It can take a lot of worry out of the decision if you know the facts and the alternatives for how they would work for your particular situation.
If you don’t have an attorney or financial advisor you feel would understand your situation, feel free to CONTACT ME and I can give you some insight and assistance to get this done right away. I can also put you in contact with some financial advisors I have worked with that definitely understand 529 plans and can help you better navigate the financial side of this decision.
Even if you looked at 529 plans and understand your tax situation, ask yourself one key question, “Is your life and situation exactly the same as it was last year?” If it is, you are probably still in good shape with regard to your estate plan. If there have been any changes in your life (even minor ones), I would strongly recommend you get your personal estate plan reviewed to ensure it will do what you expect it to. Unfortunately, the majority of plans we see are not in sync with the current situation and won’t do what people expect they will do. Lower your Risk and get your plan reviewed to ensure it is going to do what you want (and hope) it will do.
I hope this has been helpful. If you do the proper work on this, I can guarantee you will have NO. MORE. TEARS. A little bit of effort here can help you sleep much better at night knowing you can take advantage of the tax opportunities that will be present and that your Estate Plan is in order with the changes that have happened in your life.