Breaking Down 529 Plans
Jaime Aulicino, EA
With rising tuition and young adults being buried in student loan debt, planning and saving for a child’s education could be one of the most important steps that families can take.
529 plans offer a variety of benefits for parents and future students at almost any stage of their life. These plans are legally known as “qualified tuition plans” and are authorized by Section 529 of the Internal Revenue Service (IRS).
529 Contribution Limits
529 plans are designed to encourage saving for future education costs. The account holder, or saver, opens an account for the beneficiary, or student, and contributes money that grows tax-free. Donors can contribute up to $17,000 per beneficiary without needing to file a Gift Tax Return. Donors can also front-load up to 5-years-worth of contributions, which in 2023 is $85,000. In 2024, these figures will rise to $18,000 per beneficiary with a front-load amount of $90,000. Anyone can donate and/or become an account holder of a 529 plan and take advantage of the state tax deduction if their state allows.
529 Tax Treatment
For financial aid purposes, a 529 plan is owned by the account holder, not the beneficiary. This is a great benefit because when calculating the need for aid, the student’s assets are weighed more heavily than the parents’ assets. Money in the 529 plan can be used for qualified higher education expenses and will not be subject to federal income tax, or in some cases, state income tax. Pennsylvania is one of the states that will not tax the income from a 529 plan when expenses are qualified. However, if the income is not used for qualifying expenses, the money will be subject to federal and state income taxes and an additional 10% federal tax penalty on earnings.
529 Fund Transfers & Rollovers
If the beneficiary chooses not to attend a qualified institution or there is money left over after they graduate, the account holder has options to keep the money that was earned from being taxed. They can either open a new account for an eligible family member and transfer the funds there, or they can rollover the funds to a Roth IRA for the original beneficiary. In order to rollover penalty-free, the amount cannot be over $35,000, the 529 account must have been open for at least 15 years, and the funds being rolled over must have been in the account for at least 5 years. The normal Roth IRA contribution limits will apply.
There are two main types of 529 plans: Education Savings Plan and Prepaid Tuition Plan. Both options receive the same tax benefits and have the same fundamental principles. However, each one has their own advantages and drawbacks.
Education Savings Plan
An Education Savings Plan allows the saver to open an investment account for the beneficiary’s future qualified higher education expenses. These include tuition, room and board, and mandatory fees. This money can generally be used by any college or university, including some foreign institutions. Money in this account can also be used for other education-related expenses. Up to $10,000 per year per beneficiary can be used for tuition at any public, private, or religious elementary or secondary school, certain expenses for participation in registered apprenticeship programs, and qualified education loan repayments. The saver can typically choose among a range of investment options and all plans are sponsored by state governments.
Prepaid Tuition Plan
A Prepaid Tuition Plan allows the saver to purchase units or credits for the beneficiary to use in the future at participating colleges or universities. Essentially, the saver is paying for future tuition costs at current prices. The colleges and universities are usually public institutions in the state that sponsors the plan. The beneficiary could still attend a different university than the units or credits are for but may only receive a portion of the money in the plan, if at all.
Pennsylvania Law
Pennsylvania (PA) sponsors three different types of plans, one Prepaid Tuition Plan and two Education Savings Plans (one is specifically for disabled individuals). PA also has some of the best state income tax benefits for 529 plans in the country. The value of any PA 529 plan account is exempt from PA inheritance tax. And while contributions are not deductible on the Federal tax return, PA allows taxpayers to deduct up to $17,000 per donor per year. There is no annual contribution limit, however most states have a maximum aggregate limit that usually coincides with the average cost of a four-year higher education. In PA, this limit is $511,758 across all PA 529 plans for a single beneficiary.
Summary
There are many options within 529 plans that are sure to fit the needs of future scholars. Whether paying for tuition now or saving up to pay it later, this savings vehicle is certainly worth considering.
This content is for informational purposes only and is not intended to be tax or investment advice. Please speak with your trusted Louis Plung & Company advisor for more information or email: [email protected].
