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Ten big advantages of a 529 plan account

A 529 college savings plan account is a straightforward vehicle for funding future education expenses. And the parents and grandparents that fund them are probably aware of the two main tax advantages the accounts offer. But 529 college savings plans have a lot of other big advantages.

1)      No Tax on Earnings

Most people who have college funds for their children (or grandchildren) probably know that the primary benefit of a 529 plan account is that investment returns are not subject to income tax. Tax-free compounding means that more of your money is actually working for you.

2)      No Taxes on Withdrawals

The other commonly understood advantage of 529 plan accounts is that distributions to pay qualified education expenses aren’t taxed.1 And the list of what qualifies is pretty extensive.

3)      Contributions May be Deductible

Okay – and this is very important – contributions to 529 plan accounts are not deductible for federal income tax purposes! But the majority of states that impose a state income tax, also offer a deduction for at least a portion of contributions made to 529 plan accounts.

4)      Contribution Opportunities are Huge!

Annual contribution limits vary by state and typically apply to the contributor, not the account.2 In most cases, there are no annual contribution limits and lifetime account opportunities are generally in excess of $200,000.

5)      Waiver of Annual Gift tax Exclusion

Gifts to other people are generally limited to $15,000 per year per donor. Anything over that becomes taxable. And it’s the donor who pays the tax. But 529 plan accounts get a special pass.

You can front load contributions and average them over five years. So, a married couple could deposit a lump sum of $150,000 ($15,000 x 2 x 5) into a 529 plan account and characterize it as five separate gifts of $30,000 ($15,000 x 2).

6)      No Income tax Reporting Requirements

Contributions to 529 plan accounts that are over the $15,000 gift tax exclusion should be documented in a gift tax return. But there is no annual income tax reporting requirement for the contributions you make to 529 plan accounts…no matter how large those contributions are.

7)      No Income Limits

Tax-deferred retirement accounts, like Traditional and Roth IRAs, have limitations on how much (if anything) you can contribute based on your income. Contributions to 529 plan accounts have no income-based limits. You can contribute up to account limits regardless of how much money you make.

8)      Contributions are out of Your Estate

Contributions you make to a 529 plan account are gifts. Therefore, they’re out of your estate. But you don’t lose control of the money. Assets in 529 plan accounts don’t pass to beneficiaries. You decide how funds get used. You can change beneficiaries, even naming yourself.

9)      Anyone can Contribute

You are not the only person who can contribute to the 529 plan accounts you open for your kids. So, the more people (grandparents, family, friends, distant relatives, coworkers, etc.) contributing to those accounts, the faster funds can be invested and the greater the opportunity they’ll have for tax-free compounding.

10)  There are no Restrictions on Fund Withdrawals

You can withdraw money from a 529 plan account any time for any reason. Still, they really should be used just to pay for qualified education expenses. Distributions for anything else create a taxable event and may trigger additional penalties.

Taxes and penalties apply to earnings. Principal (what you contributed) isn’t taxed or penalized. But if you’ve been contributing to an account for a long time, the earnings could be worth much more than the principal. And the penalties can be severe.

Earnings withdrawn are taxed at your effective federal (and state, if any) tax rate. Then, the federal penalty is 10 percent. The state may also impose penalties. And any state income tax deduction or credit you took on contributions could also be subject to recapture.

The tax and penalty will be liable to the person who reports the income. That could be you or the account’s beneficiary.

Explore Your Options

For more information about 529 college savings plans, visit our website. Or call one of our Investment Specialists at (800) 235-8396.

 

1 In some cases, withdrawals may be subject to state tax.

2 There are exceptions for ABLE accounts, which provide tax-free savings to cover qualified disability expenses. Sources: IRS.gov, SSA.gov, Savingforcollege.com.

 

 

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