Benefitting from Section 529 College Savings Plans

Contributions to a Section 529 College Savings Plan (“529 Plan”) do not qualify for the exclusion for tuition payments, but can take advantage of the $14,000 (soon to be $15,000) annual gift tax exclusion. The contribution to the plan may also qualify you for a state income tax deduction, but only if the plan is sponsored by your state.

Distributions from a 529 Plan can be used for a wide range of educational expenses, including tuition, fees, books, supplies, and room and board. An added advantage of a gift to a 529 Plan is that the income earned on the contribution is tax-free, as long as the contribution is eventually used for educational purposes. And because you can name yourself as the custodian of the account, you ensure that your beneficiary uses the account for educational purposes.

There are two types of 529 plans: Prepaid Tuition Plans and College Savings (Investment) Plans. A Prepaid Tuition Plan locks in the current costs of tuition and protects against future increases in the costs of education. A College Savings Plan does NOT lock in current costs, but rather allows for savings to be applied against actual future costs, which will likely be much higher than current educational costs.

College Savings Plans have grown in popularity and overtaken Prepaid Tuition Plans. In fact, several prepaid tuition plans have stopped accepting new enrollees or shut down entirely. This is because Prepaid Tuition Plans have drawbacks. For example, money put into a state-run Prepaid Tuition Plan may only be applied to tuition and fees at in-state public colleges and universities. Further, room, board, books and other expenses aren’t included and must be covered separately.

For College Savings Plans, eligible institutions include most accredited colleges and graduate schools, including professional and trade schools. Contributions apply to a variety of qualified educational expenses, including tuition, books and room and board for those attending at least half time.

Approved transactions (“qualified withdrawals”) vary slightly from plan to plan. Contributions for unauthorized purchases may result in recapture of tax deductions and/or additional penalties.

Most states offer multiple 529 plans. Dozens of state plans are sold nationally, regardless of where the account owner lives. Don’t limit yourself to your own state’s offerings, particularly if you live in a state (other than Pennsylvania!) with no income tax. Each plan comes with corresponding fees, including maintenance and investment fees.

A 529 Plan purchased from a financial advisor (rather than a state) may have additional advisor fees which could increase your Plan’s total cost. Such fees must be considered and compared against the benefit of any in-state tax deduction.

529 Plans vary from state to state, even though they tend to be similar. Compare tax deductions, fees and expenses to find out if your state’s Plan is fairly priced.

State tax deductions are the best incentive for residents to use one of their state’s 529 plans. Pennsylvania (as well as Montana, Arizona, Kansas and Missouri) offers its residents tax deductions for contributions to any 529 plan.

Each state enforces a unique contribution maximum, which limits the total amount of money you can contribute to one beneficiary. This maximum applies even if multiple people open an account for one beneficiary. Once you reach this limit, your 529 account(s) will no longer receive your deposits. Take this into account if you plan to invest a large sum of money in a college fund. Contribution limits are typically between $235,000 and $512,000 per beneficiary. Check the rules in your state.

Unlike Prepaid Tuition Plans, most College Savings Plans do not require withdrawals within a certain period of time or impose stringent age requirements.

Every state allows a once-per-year rollover to another 529 Plan with no tax consequences. However, many states will charge you for transferring your account, or recapture your state tax deductions if you move from an in-state plan to an out-of-state plan.

Under special rules unique to 529 plans, you can gift a lump sum in a given year–up to $70,000 in 2017 and $75,000 in 2018, for individual gifts and $140,000 or $150,000 for joint gifts–and avoid federal gift tax by making a special election to treat the gift as if it were made in equal installments over a five-year period. You make this election on a federal gift tax return filed by April 15 of the year following the gift. For example, if you make a $70,000 contribution in 2017 and then make the election, your contribution will be treated as if you had made a $14,000 gift for each of five years.

If you make a lump sum 529 Plan gift, elect to spread the gift over five years, and then die before the five-year period has ended, the portion of your contribution allocated to the years after your death will be included in your federal estate. For example, suppose you make a $70,000 contribution to a 529 plan in Year 1 and elect to spread the gift over five years. You then die in Year 2. The result is that your Year 1 and Year 2 contributions of $14,000 each ($70,000 divided by 5 years) are not part of your estate, but the remaining $50,000 would be included in your federal estate.

Section 529 Plans can be complicated. Please contact us if you would like to discuss your Section 529 Plan gifting options.