One of the most popular ways to save for college is by contributing to a 529 college savings plan. As I’ve written in the past, these plans have benefits over other methods of saving for college. The 529 plan has many advantages for save for higher education and are designed to allow parents or others to maintain more control of the money deposited into the account. Let’s review some of these advantages:
Contributions to 529 plans are not eligible for federal tax deductions, but many states allow parents to deduct a portion of their 529 contributions from their state income tax liability. Depending on your tax bracket, this could be a large savings each year.
In addition, earnings and growth inside a 529 plan may grow federal-tax free. And if funds are withdrawn from a 529 account to pay for qualifying higher education purposes, taxes and penalties won’t be due on the withdrawals.
Maintaining control of the account
Contributions to a 529 account are owned by the parent or other trustee set up on the account for the benefit of the named child. In almost all instances, the named beneficiary has no right to the money in the account. This is an important point. Before 529 accounts were available, parents set up custodial accounts to save for their children’s college expenses. With custodial accounts, as soon as the child reaches legal age of majority (either 18 or 21 years old, depending on the state) parents lost all control and the money automatically belonged to the child. If your child decided to use the money for any purpose besides college, that was entirely within his right.
An owner of a 529 account is not required to make withdrawals from an account, meaning that if your child defers college or receives financial aid, you may not need to make a withdrawal. Also, an owner can withdraw funds at any time for any reason. Remember to be careful about this, as any earnings from a non-qualified withdrawal will incur income tax and an additional 10 percent penalty tax.
Additionally, beneficiaries on the account can be changed at any time if proper rules are followed. This means that if one of your children receives a full scholarship to college, you can change the beneficiary to another family member. And, you’ll also be able to roll one child’s plan into another child’s plan without penalty.
Simplified tax reporting
For 2018, the annual gift tax exclusion is $15,000, meaning each parent can contribute up to the maximum without having to report it on your federal tax return. Since these accounts are tax deferred, a Form 1099 will not be generated for any capital gains and dividends. A Form 1099 will only be generated to report taxable or nontaxable earnings when a withdrawal is made from the account.
Everyone is eligible
One of the greatest benefits of a 529 plan is that there are no restrictions on contributions. The 529 plan does not have income limits, age limits, or annual contribution limits (subject, of course, to the annual gift tax allowance. Consult your accountant if you plan on contributing more than $15,000 in 2018). There are, however, lifetime contribution limits, which vary state by state. Therefore, it is very important to consult your financial advisor when contributing to a 529 plan, especially if grandparents or others maintain 529 plans for the benefit of your children.
‘Superfund’ your college savings
A special provision written into the law about 529 plans is that contributors can make a lump-sum contribution equivalent to five times the current annual gift tax exclusion amount. This means a parent (or grandparent) can contribute $90,000 in 2018 and elect to spread the gift evenly over five years. This type of contribution avoids the federal gift tax if no other gifts are made to the same beneficiary during the five-year period. A married couple can, of course, both contribute, making a total amount of up to $180,000.
Anthony N. Corrao is the founder and managing director of Corrao Wealth Management. For more than 25 years he has helped families towards their financial goals by developing financial, educational, and retirement planning strategies.
The information is intended for informational purposes only, and is not intended to be a substitute for specific tax, legal, or investment advice. Securities offered through First Allied Securities Inc., A Registered Broker Dealer. Member FINRA/SIPC. Advisory services offered through First Allied Advisory Services, A Registered Investment Adviser.