How’s Your 529?

How’s Your 529?

| July 20, 2022

If you’ve got concerns about your college plan, we’ve got answers to common questions.

Education is perhaps one of the best investments there is, since it opens up a whole world of future potential. By 2037, the latest projections from savingforcollege.com say, four years studying at a public university in-state will run more than $167, 600. Getting ahead of those costs early can be a big help — which is why 529 plans, which allow you to save for school and accumulate interest tax-free, are such a popular solution.

But there are still some persistent questions about managing the ins and outs of a 529 plan. Yes, if you don’t use the money you’ve saved (and the profits it’s earned) for education, you’ll have to pay taxes on it as earnings plus a 10% penalty. But there are more ways to use it than you might expect. It’s always worth asking a financial advisor about any apprehensions you have, or even any assumptions you’ve been making about how these savings plans work. Here are a few examples:

If my kid gets a free ride, will a 529 wind up costing me?

Getting a scholarship is always a cause for celebration. If you’re fortunate enough to qualify for scholarship funds, you may be eligible to withdraw up to the scholarship amount without incurring the penalty. If the scholarship is tax-free, though, the amount you withdraw could be taxed as ordinary income.

Does the 529 plan have to go towards an undergraduate degree?

Nope! It does have to pay for education, but a couple of relatively recent laws have broadened the definition of qualified higher education expense, or QHEE. For college, you can withdraw any amount you need to cover QHEE, which, besides tuition, can include mandatory fees, room and board, textbooks, and other essentials. But after 2017’s Tax Cuts and Jobs Act, 529 plans are allowed to pay up to $10,000 a year for tuition at K-12 schools.

Thanks to the 2019 SECURE Act, your 529 plan can also cover required fees, books, supplies, and equipment for an apprenticeship program that’s certified with the U.S. Department of Labor. And your family can also allocate up to $10,000 in 529 savings per student to help pay off student loans … either for the beneficiary or their siblings.

Can I only chip in a certain amount per year for a 529 plan?

Other kinds of college savings plans, like a Coverdell Education Savings Account, put limits on how much you can contribute per year. Contributions to a 529, however, can be as much as needed to cover your anticipated qualified expenses, with one caveat: There’s a cap on how large the account’s total balance can be, which varies from state to state.

If I take out too much money, am I going to have to pay a 10% penalty on all of it?

Maybe not. If you’re paying for qualified education expenses and you withdraw too much, the 10% penalty only applies to the amount over those expenses. And remember that QHEE can also apply to things like apprenticeship equipment and siblings’ student loan payments.

In general, it’s a good idea to keep in mind those expenses that aren’t qualified, which include sports activity fees, insurance, transportation, and any room and board above what the university includes in its “cost of attendance” figures for federal financial aid. The school’s financial aid department should be able to tell you the room-and-board allowance for students living off campus.

Do I have to use my state’s 529 plan? And does my kid have to go to an in-state school to use it?

This is a common misconception. Because 529 plans are issued by states, it seems logical that they’d be limited to residents of that state and to educational institutions in that state. For prepaid tuition versions of 529s, this is often the case — but anyone can start other kinds of 529 plans in any state, and those 529 plans can be used to cover educational expenses you incur in any state and still offer you federal tax benefits.

One thing to bear in mind, though, is that some states do offer 529 plans that extend benefits to state income taxes. If you’re not a resident there, those benefits wouldn’t apply. On the other hand, states like Pennsylvania, Kansas, Arizona, and Minnesota extend their state tax benefits to residents who get any 529 plan, even if it’s out of state. It can be worth it to shop around and see which state’s plans perform the best or offer the best incentives for your situation.

If the kid doesn’t wind up going to college, is the money lost?

No. There are several options: You can keep your 529 open in case the original beneficiary changes their mind and goes to college, vocational school, or qualified apprenticeship later. You can withdraw the fees and pay the applicable taxes and possible penalty. Or, you’re allowed to transfer the funds to another beneficiary. That recipient has to be what the IRS considers a “qualified family member” of the beneficiary: a sibling or step-sibling; a spouse; a child or descendant; a parent or ancestor; a son- or daughter-in-law; a brother- or sister-in-law; or a first cousin. But as long as they’ve got qualified educational expenses, they can use the transferred funds.

Am I the only one who can contribute to my child’s 529?

No— In fact, anyone can contribute to a 529 plan: aunts, uncles, grandparents, cousins, etc. 529 plans make a great gift option. It is a common choice of grandparents looking to contribute financially while also getting tax deductions. Additionally, there are new rules anticipated to go into effect in 2024 that state grandparent-owned 529 plans will no longer need to be reported on FAFSA, possibly increasing the student's eligibility to get financial aid.

CONTACT US to schedule a review with one of our financial professionals today to discuss your college savings strategy to ensure that your family is on the right track.

SOURCES:

Investors should consider the investment objectives, risks, charges and expenses associated with municipal fund securities before investing. This information is found in the issuer’s official statement and should be read carefully before investing. Investors should also consider whether the investor’s or beneficiary’s home state offers any state tax or other benefits available only from that state's 529 Plan. Any state-based benefit should be one of many appropriately weighted factors in making an investment decision. The investor should consult their financial or tax advisor before investing in any state's 529 Plan.