529 Plans: College & Legacy Planning

presented by Alison Wilcox

529 Plans: College & Legacy Planning

First of all, what is a 529 Plan? The 529 state savings plan is a tax-advantaged college savings vehicle governed under Section 529 of the Internal Revenue Code (IRC)—hence the name “529” plans. A state savings plan lets you save money for college in an individual investment account. Don’t let the “education” aspect prevent you from thinking of this as a potential legacy account, though. The list of qualified expenses from a 529 account continues to grow, and money can always be accessed for other purposes as well.

Tax Treatment

Your contributions grow tax-deferred, which means you don’t pay income tax on the account’s earnings each year. While not federally tax deductible, contributions to 529 plans are tax-deductible in some states, up to certain limits such as $4,000 per taxpayer per year in Virginia, and $1,000 per taxpayer per year in Massachusetts. For this reason, individuals may choose to contribute as much as possible in their high income earning years. Check with your state for specific tax deductibility information.

Contributions to 529 plans are subject to annual gift tax exclusions, currently $16,000 per year per donor/giftee. However, there is also an option to superfund a 529 account without triggering the gift tax. In 2022, an individual may contribute up to $80,000 to a 529 account and spread the gift out evenly over five years by filing Form 709 with their tax return, effectively gifting $16,000 per year for five years. Superfunding in year one provides the opportunity for those contributions to grow in a tax free environment for a longer period of time.

College Planning

Money withdrawn to pay college expenses (a qualified withdrawal) is tax-free at the federal level and may also be tax-free at the state level. See 529 Plans: Qualified vs. Non-Qualified Expenses for a list of qualified versus non-qualified withdrawals. If the money is not used for a qualified expense, you will owe income tax and a 10-percent federal penalty on the earnings portion of the withdrawal.

Years ago, 529 funds could only be used to pay for college expenses, but since then the list of eligible expenses has been expanded to include $10,000 per year of elementary, middle and secondary school tuition, as well as some graduate education expenses. If your state allows, you can also use up to $10,000 per year to repay federal or private student loan debt.

Legacy Planning

529 accounts can also be used as an estate planning tool. This type of account is unique in that it provides an opportunity for the account holder to make a revocable, irrevocable gift. Unlike other gifting strategies employed to remove assets from your estate, with the 529 plan you can change the name of the beneficiary as well as the account owner after the gift is made. If handled correctly, you can generate a source of tax-free funds for your children, grandchildren and possibly beyond that.

There is no limit on the number of 529 accounts you can have, so if you have multiple children or grandchildren, you can open one for each. This, combined with the superfunding strategy mentioned earlier, creates an opportunity to lower the value of your estate for tax purposes while providing an attractive option for providing legacy educational support for generations to come.

If you have a question about how to put 529 accounts to work for you for college or legacy planning that is not answered here, click below to submit a question to our team. 

*The fees, expenses, and features of 529 plans can vary from state to state. 529 plans involve investment risk, including the possible loss of funds. There is no guarantee that a college-funding goal will be met. In order to be federally tax-free, earnings must be used to pay for qualified higher education expenses. The earnings portion of a nonqualified withdrawal will be subject to ordinary income tax at the recipient’s marginal rate and subject to a 10-percent penalty. By investing in a plan outside your state of residence, you may lose any state tax benefits. 529 plans are subject to enrollment, maintenance, and administration/management fees and expenses.

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