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The cost of education continues to soar. Paying for the education of your children, grandchildren, or other loved ones may be an important part of your estate plan. One option is state-sponsored 529 saving plans, which are popular due to their income tax-saving benefits. The funds in 529 plans grow income tax-free and can then be withdrawn to pay for various education expenses such as tuition, fees, books, supplies, and specialty equipment. In this blog, we explore some of the finer details of 529 plans by answering a few of the most frequently asked questions regarding these plans.
Must you choose the 529 sponsored by your state?
Most states offer at least one 529 plan. Each state’s plan may differ and offer various investment options. You do not have to invest in your own state’s plan, but many states offer residents a state income tax deduction for doing so. For example, in Maryland, you can deduct up to $2,500 of payments estate each from your Maryland State income per account. Payments of more than $2,500 per account can be deducted in future years until the full amount of payments have been deducted. The state that sponsors the plan does not require that your child attend a school in that state; students can use the money to attend a school in any state. The exception to this rule is a prepaid plan where you prepay expenses for a state school to lock in today’s costs.
Who controls the account?
Generally, the same person who contributed to the 529 plan controls the account. However, you may also open an account and name the child’s parent as the owner, or a parent can establish an account and allow others to contribute to it. As the account owner, he or she chooses the investments, names the beneficiary, and withdraws the funds on behalf of the beneficiary when necessary.
What Constitutes “Qualified Education Expenses”?
529 savings plans can pay for tuition and other supplies necessary for education, as well as room and board for students who spend at least half of their time living on campus. Relevant school supplies covered by 529 plans include computers and peripheral equipment (e.g., printer), software (educational in nature or for work produced in connection; generally, not for entertainment and gaming), and internet service for the years in which the beneficiary is enrolled. 529 plans can also be used for up to $10,000 per year for the costs associated with elementary and secondary education (K-12) for public, private, or religious schooling. Also covered by 529 plans are any special needs services needed for a special needs beneficiary in connection with their school enrollment and attendance. 529 plans do not cover the following expenses:
- Application fees and testing and test prep services
- Insurance (health, auto, renters, etc.)
- Transportation to and from campus
- Sports or club fees
- Dorm furniture and decorations
- Living expenses more than the “cost of attendance” (financial aid offices can often provide some guidance and expectations on these limits)
Can a 529 Plan be used to pay for non-traditional education programs?
Higher education counts for more than just bachelor’s degrees. In addition to traditional 4-year undergraduate programs, 529 plans can also be used for:
- 2-year community college programs
- Certain vocational training/trade-schools
- Registered apprenticeship programs
- Higher education programs without degrees
- Higher education programs for advanced and post-graduate degrees
- Certain international degrees
Can you change the beneficiary of a 529 plan?
If the named beneficiary does not use all the funds in his or her 529 account, the beneficiary can be changed to another individual, including the beneficiary’s spouse, child, sibling, parent, grandparent, stepparent, aunt, or uncle. 529 plans can be rolled over to any spouse of those persons listed. If the new beneficiary of the 529 plan is not in the same generation as the previous beneficiary, there may be a Generation Skipping Transfer Tax. Regardless, 529 plans are still a useful tool for growing funds tax-free for future generations. 529 plans can also be rolled into an ABLE account for the original beneficiary or a family member of the original beneficiary until January 1st, 2026. The transfer of 529 plans into an ABLE account is subject to the other contribution limits set forth for ABLE accounts.
Is there a limit to the amount which can be contributed to the 529 account?
There are no annual contribution limits to a 529 account, but there are maximum aggregate limits, which vary by plan. The contributions to a 529 account are considered completed gifts for federal tax purposes. Currently, up to $16,000 per beneficiary qualifies for the annual gift tax exclusion. A special 5-year election allows you to contribute up to $80,000 to an individual’s 529 account in a single year by spreading it out over 5 years if reported on a timely filed gift tax return.
What are the Penalties for Making Withdrawals from a 529 Plan that are not qualified education expenses?
Withdrawals from a 529 plan for reasons other than for qualified education expenses are generally subject to a 10% tax penalty. Only under certain exceptions can the penalty be avoided, such as when the beneficiary is disabled (as defined by the IRS), or when the designated beneficiary receives a scholarship. For beneficiaries with scholarships, account holders can withdraw money from the 529 plan up to the tax-free amount of the scholarship. The withdrawn funds can be used to cover extra living expenses or other costs for beneficiaries that do not otherwise count as “qualified education expenses.” Up to $10,000 total can be used to repay student loans of the designated beneficiary or a sibling of the designated beneficiary. If you would like to learn more about options for education funding for your estate plan, as well as other potential tax-saving strategies to help benefit your loved ones, we encourage you to reach out to our office to schedule a meeting.
At Sessa & Dorsey, we consider the bigger picture at hand and advise our clients on the best estates and trusts for their specific needs and desires. If you have questions, please contact us at (443) 589-5600.
Related blog posts:
Relevant Maryland Legislature Passed in the 2022 General Assembly Session
Estate Planning Documents For Your College Student
Estate Planning 101: Education Funding for Children and Grandchildren
What Are Gift Tax Returns and Who Needs to File Them?