A 529 plan is an investment program that provides families with an easy and effective means to save for future college costs as well as tuition expenses at an elementary or secondary public, private or religious school.3 529 plans can also be used for apprenticeship programs as well as qualified education loan repayments.4 But 529 plans also have tax, retirement and estate planning implications that extend far beyond this basic purpose. Most states have a 529 plan of some sort. Most of these programs are open to residents and nonresidents of the sponsoring state, so you can shop among them for the one that best meets your objectives.
Do not assume you are not in a position to use a 529 plan. Unlike most other tax-advantaged programs, 529 plans are open to everyone, regardless of income level or the age of children or grandchildren. You do not even need to have children or grandchildren — you can establish an account for your niece, nephew or, with some plans, yourself. Many 529 plans, depending on the state, will allow you to make contributions up to a $300,000 or more account value with no time limit on its use. Check the plan’s disclosure materials for details.
Your investment professional can show you how a 529 plan may fit into your financial picture and help you select the one that is right for your family. You can do the research on your own, but you will find that the investment options and program features vary considerably among the different programs, and the comparisons can become confusing.
There are two general types of 529 plans: prepaid tuition plans and education savings plans. States may offer one type of plan or the other, and some states now offer both.
Earnings in 529 savings plans are tax deferred, and withdrawals are free from federal tax if used for qualified education expenses. If you withdraw money for something other than qualified education expenses, your earnings will be subject to federal income tax and a 10% federal tax penalty. There are exceptions to the penalty if the beneficiary dies, becomes disabled or receives a scholarship that reduces his or her need for college funds.
At just about any accredited post-secondary American institution, including graduate schools, qualified education expenses from a 529 savings plan include the cost of
In addition, room and board expenses can qualify (subject to limits) if the student is attending college on at least a half-time basis.
Lastly, 529 savings plans may also be used to pay for costs associated with apprenticeship programs, as well as K through 12 tuition up to $10,000 per year, and qualified loan repayments for the beneficiary and siblings up to $10,000 over the lifetime of each individual.
With a 529 plan, you can help fund education expenses while potentially reducing estate taxes — which makes it a great tool for many grandparents. For the 2022 tax year, you can gift up to $16,000 ($32,000 per married couple) per beneficiary without incurring federal gift-tax consequences. Or you may gift up to $80,000 ($160,000 per married couple) to each beneficiary. You do not incur federal gift taxes as long as no additional gifts are made to the beneficiary for four years after the year in which you make the one-time gift and the appropriate tax form is filed.5
For each prepaid tuition contract or savings plan account, there is an owner (generally the donor) and a beneficiary. You name a beneficiary when you set up an account; the individual you name does not have to be related to you.
With a 529 plan, you are the owner and retain all rights to the account, including the right to determine when withdrawals are taken and what they are used for. You can change the beneficiary to another relative (of the beneficiary) at any time, and you can even decide to withdraw the funds for your own use and close the account (the earnings portion of nonqualified withdrawals will incur federal income tax as well as a 10% penalty).
The following example demonstrates how powerful this opportunity can be. Grandma and Grandpa have significant wealth, including $1.2 million in cash that they wish to leave to their grandchildren. They want to reduce their estate tax exposure and like the idea of targeting some of their money for the education of their seven young grandchildren. They decide to contribute $160,000 into a 529 plan on behalf of each grandchild. The result is that Grandma and Grandpa have removed $1,120,000 ($160,000 x 7 grandchildren) from their estates in one day, without gift tax consequences and without incurring the costs associated with irrevocable trusts.6 Further, the contributions are invested in a professionally managed investment account that may grow tax deferred without the burden of annual income taxes. And best of all, Grandma and Grandpa can always get the money back if they do not mind paying income tax plus a 10% penalty tax on their earnings.
According to the US Department of Education, if the parent is the account owner, the assets in a 529 savings plan account are treated in the federal financial aid formula for college as assets of the parent. Since parental assets are generally assessed at a maximum 5.6% in determining aid eligibility (as compared with 20% for assets owned by the student), a 529 plan owned by the parents may help families qualify for more student aid.
Each state-sponsored 529 plan is free to design an investment approach that it feels will best accomplish the goal of saving for college. One condition imposed by tax law is that the account owner in the 529 plan may not have the unlimited ability to direct the investment of the account. For example, as the account owner you can reallocate your account balance among investment options only twice per year or upon a change to the designated beneficiary of the account. Although this somewhat paternalistic provision is seen by some as a reason not to use 529 plans, the fact is that among the many 529 plans offered, there are a variety of investment approaches. Many plans have outsourced the investment and program management to large financial services companies.
And many plans now offer an “age-adjusted” investment program. Your account is invested primarily in equity funds while your child is young and shifts to more conservative fixed income funds as your child gets closer to college age. In addition to an age-adjusted program, some plans now include a menu of fixed-allocation investment portfolios, ranging from allequity portfolios to 100% fixed income portfolios.
There are additional fees associated with 529 savings plans. Investments in 529s are generally municipal securities and involve investment risks. You should consider your financial needs, goals and risk tolerance prior to investing.
Be sure to investigate the 529 plan in your own state and see if it offers any special features or benefits to state residents (such as a tax deduction for your contribution, matching grants or state financial aid preference). Depending on your state of residence and the state of residence of the beneficiary, an investment in a 529 plan may not afford you or your beneficiary state tax benefits or other state benefits only available for investments in such state’s qualified tuition program.
Shop around and look at other 529 programs, both those sponsored by other states and those sponsored by institutions. Consult your financial advisor or investment professional for help with understanding how 529 plans work and to compare the details of competing plans. The effort may be worth it if you are looking for a tax-advantaged way to save for future education expenses.
Less taxing, greater growth potentialAn investment in a tax deferred vehicle has the potential to accumulate more money over a long period of time.
Annual return: 6% Initial2 investment: $10,000 Tax bracket: 24%This example is for illustrative purposes only and is not intended to predict the returns of any investment choices. Rates of returns will vary over time, particularly for long-term investments. There is no guarantee the selected rate of return can be achieved. The underlying investments of your 529 plan may have fees and expenses that are not taken into account in this illustration. The performance of the investments will fluctuate with market conditions. If there are no earnings, the account will not grow.
529 plans provide several benefits, including
529 plans allow you to
1MFS calculations based on data from College Board’s Trends in College Pricing 2021.2Compounded monthly.3Beginning in 2018, for federal tax purposes, any references to the term “Qualified Expenses” include expenses of up to $10,000 per year for tuition in connection with enrollment or attendance at an elementary or secondary public, private or religious school.4The Setting Every Community Up for Retirement Enhancement Act of 2019 (the SECURE Act) expanded qualified education expenses to include apprenticeship program’s required fees, books, supplies, and equipment, as well as qualified education loan repayments for the designated beneficiary or a sibling of the beneficiary. Distributions for loan repayments are limited to $10,000 total over the lifetime of an individual beneficiary.
MFS Fund Distributors, Inc. is not affiliated with LPL Financial or StrateFi Wealth Management.
This material is provided for general and educational purposes only and is not investment advice. The investments you choose should correspond to your financial needs, goals, and risk tolerance. Please consult a financial advisor or investment professional before making any investment or financial decisions or purchasing any financial, securities or investment related service or product, including any investment product or service described in these materials.
Any statement contained in this communication (including any attachments) concerning U.S. tax matters was not intended or written to be used, and cannot be used, for the purpose of avoiding penalties under the Internal Revenue Code. This communication was written to support the promotion or marketing of the transaction(s) or matter(s) addressed.
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