THE “SIMPLE” §529 PLAN

Roy S. Gilbert, JD*, CLU, ChFC

September 14, 2022

A §529 Plan is a tax-advantaged savings plan legally known as a “qualified tuition plan,” sponsored by states, state agencies and educational institutions. There are two types of §529 plans: prepaid tuition plans and education savings plans.¹¹ My references to §529 plans in this article will be limited to the education savings plans.

The big draw of the §529 plans are the potential income tax advantages. The withdrawals or distributions from the plan are tax free to the extent they are used for qualified education expenses. These are referred to as qualified distributions. But if you take non-qualified distributions, there may be reportable income and a 10% federal penalty on the gain portion of the withdrawal.⁹

Note that the 10% penalty on a non-qualified distribution may be waived in certain circumstances. Two such examples may include non-qualified distributions made to the estate or heirs of a deceased beneficiary or to a disabled beneficiary. However, the earnings may still be taxable.¹⁰

I’ve heard §529 plans defined succinctly as “college savings accounts for your children.” And they are…or are they? Let’s take that simple statement apart.

Is it really a savings account?

Well, it can be…but maybe not a savings account in the traditional sense. A §529 education savings plan is usually an investment account, not a savings account in a bank. Every state except Wyoming offers its own plan. Wyoming has adopted Colorado’s plan.¹

Although IRC §529 may provide some federal income tax benefits in connection with these plans, each state will have their own rules about the state income tax treatment of these funds.In addition, each state’s plan may have its own rules on minimum and maximum contribution amounts.²Some states may offer more than one plan – possibly both a direct-sold plan and an advisor-sold plan may be available. These plans may differ in offerings and in fees.³

Bottom line - it is prudent to make sure you are familiar with the state plans that you are interested in.

Is it really an account just for college?

In many cases it is, and college may have been the most significant original intent and use. But the potential tax advantages of a §529 plan are available where the proceeds are used for any qualified educational expenses. In addition to college, qualified educational expenses can include up to $10,000 a year in K – 12 tuition and a lifetime amount of up to $10,000 in student loan repayments, among other things.⁴

You may be able to use §529 plan funds for required books and supplies, necessary special needs equipment, peripheral computer equipment software and internet access and some room and board expenses.⁴

Bottom line – it would be wise to have an understanding of how to get the most from your §529 funds to coordinate with any other educational savings you might have.

Is it really just for your children?

Quite often it is, but here’s where there may be some really creative flexibility. §529 accounts have an account owner and a beneficiary. Sometimes a successor owner is also named. The funds in the plan are under the owner’s control – not the beneficiary’s control (unless the beneficiary is also the owner). Usually, the owner is the one that contributes to the account, but others may also contribute.⁵

Where an independent student is both beneficiary and owner, these funds may need to be reported on the FAFSA form (Free Application for Federal Student Aid) as the student’s assets. Such reporting may negatively impact eligibility for financial aid to a much greater extent than if the account was owned by the parent.⁶

Interestingly, if the §529 account is owned by a grandparent, it may escape reporting on the FAFSA altogether and its existence may not impact financial aid eligibility.⁶However, if the grandparent provides financial support to the student – including §529 withdrawals, the support may be reportable as student income on the FAFSA.⁸

The beneficiary of a §529 plan can be changed to a qualifying family member at any time without income tax consequences. The group of qualifying family members is quite broad.⁷So, if there are leftover funds in the plan, changing the beneficiary can avoid the taxes and penalties which may be associated with non-qualified plan distributions.

Bottom line – it may be prudent to plan some alternative exit strategies in the event the primary benefit doesn’t need some, or all, of the plan funds.

What does all of this mean? It means that there are several factors to be considered in connection with §529 education savings accounts. It is beyond the scope of this article to go into detail about the differences between the plans in different states or about specific income, gift and estate tax considerations.

529 accounts can be financial chameleons. There’s a lot of flexibility, and with flexibility come benefits and complexity. Choosing the right plan, the right owner for the right purpose, coordinating with the remainder of your planning and funding it beneficially can involve some strategic planning.

This is not one of those “don’t try this at home” pleas. However, the complexity of the rules and the coordination of §529 accounts with other planning can result in missing some benefits. This is an area where getting some help can be beneficial. Please do not hesitate to contact us if you would like to discuss this subject further or if you have questions about your §529 planning. Remember, we are here to help.

CRN-3786663-092421