529 Essentials: 529 Primer

By Paul Curley | paul.curley@strategic-i.com | July 7, 2016

A 529 Plan is a tax advantaged education savings plan operated by a state or educational institution designed to help families of all income levels set aside funds for future college costs.

What: A 529 Plan is a tax advantaged education savings plan operated by a state or educational institution designed to help families of all income levels set aside funds for future college costs. It is named after Section 529 of the Internal Revenue Code which created these types of after-tax savings plans in 1996, and any U.S. Citizen or resident alien is eligible to open an account. 

Why: 529s are currently helping over 7 million families earmark over $250 billion in savings in over 12 million accounts for future higher education expenses to minimize debt, improve college affordability and build financial stability over the long-term and across generations. Also, advisors have noted that 529s provide them with a marker of their value provided to clients, as parents and grandparents may not open them on their own. Based on Strategic Insight’s 529 Consumer Survey in 2016, only 68% of American parents save for college and only 32% save efficiently with a 529 plan. Therefore, advisors have an opportunity to add value through efficient college financial planning for their clients.

Tax: In addition to the value of saving for a dedicated goal in an earmarked account that clients can track, many parents and advisors use 529 plans due to state tax incentives and contributions growing tax-free, and the ability to make tax-free distributions when used for tuition, room and board (if registered as at least a half-time student) and other qualified higher education expenses at eligible schools. Otherwise, the gains portion of the distributions are subject to a 10% penalty and taxes. There are exceptions to the penalty, and those will be covered in next week’s 529 Dash. As for the list of roughly 7,000 eligible institutions, it includes colleges, universities and vocational schools in the United States and aboard that are eligible to receive funds from a federal student aid program. While the vast majority of 529 plans are not restricted to in-state residents and users of 529 college savings plans are not limited to in-state colleges, you should read the plan disclosure statement before investing in a 529 prepaid plan for any residency related requirements residency. Lastly, distributions can typically be paid to the student, parent or college depending on the specific 529 plan. 

Benefits: 529 plans are flexible, and do not have age or income restrictions on who can invest in them. Additionally, anyone can contribute to a 529 plan, and so the account can grow by crowdsourcing from friends and family members. In contrast, Coverdell Education Savings Accounts generally limit contributions when the account beneficiary is 18 years old or older, and require that all assets get distributed from the account by age 30.


--- Financial Aid: 529s also provide beneficial financial aid treatment. 529s held in a parent's name are treated as a parental asset which reduces the expected family contribution at a rate of up to 5.64%, compared to 20% of assets held in the name of the student. Also, withdrawals from a 529 do not impact financial aid as they are not counted as income. 

--- Portability: Also, 529 plans are portable in that you can change the designed beneficiary to another family member without tax consequences. 

--- Gifting, Estate Planning & Family Dynamics: Another benefit is that assets are removed from a contributor's taxable estate. While some plans have a claw back provision if a contributor passes away in less than 5-years, beneficial estate planning treatment does provide value to some 529 users. A part of this estate planning functionality is that the accountholder gets to maintain control of the account, and can change the ownership of the account from one grandchild to another family member at any time. In contrast, the grandparent gives up control of account with most types of trust accounts. In order to accelerate the estate planning benefit of 529s, the  annual contribution limit is $14,000 as of 2016, or the accountowner can make a 5 year gift in one year up to $70,000 individually or $140,000 per couple to each child's 529 plan without triggering federal gift-tax consequences. While this is a significant amount of assets, no other gifts are allowed to be made to the same beneficiary during 5-years. Lastly, 529s provide high lifetime contribution limits, as the accountholder can contribute up to high maximum set by state which is generally over $200,000 per accountowner beneficiary relationship. Lastly, accountowners are allowed 2 investment changes per calendar year for the same beneficiary within the same 529 plan, 1 change in 529 plan for the same beneficiary per 12 months and unlimited changes in beneficiary to another family member of the previous beneficiary. 529s help families earmark savings specifically for college in a tax, financial aid and estate planning efficient manner. Next Week, we will cover qualified distributions, beneficiary changes and rollovers.