Understanding the Ins and Outs of 529s

529 plans have long been recognized as valuable tools for saving for college, but understanding the ins and outs of these plans is crucial to maximizing their benefits. From contributions to withdrawals, here’s what you need to know:

Contribution Limits: To maintain their status as qualified education savings vehicles, 529 plans adhere to federal guidelines. In the past, this meant limiting contributions to cover five years of tuition, fees, room and board at the priciest college. However, recent changes have broadened these limits to encompass the costliest schools in the country, including graduate school expenses. Consequently, most states now set contribution limits of $350,000 or more, adjusting annually to account for rising college costs.

These limits apply per beneficiary, regardless of the plan type (savings or prepaid tuition). For prepaid tuition plans, the state limit represents the total contributions. In contrast, savings plans impose a cap on the account’s value for a beneficiary. Once the account reaches the state limit, further contributions are not accepted.

Minimum Contributions: Some plans require minimum contributions, which can involve an opening deposit, a minimum amount for each contribution, or an annual contribution threshold. However, many plans waive or reduce these requirements for account holders using automatic payroll deductions or bank-account debits. Such arrangements may also come with waived fees. It’s worth exploring these options to make the most of your contributions.

Other Contribution Rules:

  • Only cash contributions are accepted; non-cash assets like stocks or mutual funds must be liquidated before investing in a 529 plan.
  • Contributions can come from anyone, not just the account owner.  The account owner is the only one that can deduct direct contributions on their state income tax return, if applicable.
  • 529 savings plans offer various investment portfolios, allowing flexibility to change options including age-based portfolios that adjust the risk level as your child gets older.

Qualified Withdrawals: Withdrawals used for qualified education expenses remain tax-free at the federal level and may be exempt from state income tax. These expenses include tuition, fees, books, equipment, room and board (at least half-time attendance) for college/university, certified apprenticeship programs, trade schools and vocational programs. In addition, qualified withdrawals include student loan repayment (up to $10,000 per beneficiary), and K-12 tuition expenses up to $10,000 per year.

Nonqualified Withdrawals: Taking funds from a 529 plan for expenses unrelated to education constitutes a nonqualified withdrawal. The earnings portion of such withdrawals is subject to federal income tax and a 10% penalty, potentially triggering state penalties and taxes as well. The contributions are not taxed when withdrawn.

Timing Withdrawals: As an account owner, you have control over when and how much to withdraw. To optimize your strategy, coordinate withdrawals with education tax credits and aim to leave funds in the plan as long as possible for continued tax-deferred growth.

Maximizing Contributions: While you can’t time contributions to minimize federal taxes, making the maximum annual contribution can be advantageous. Contributions up to $17,000 annually in 2023 qualify for the federal gift tax exclusion. Additionally, unique to 529 plans, you can gift a lump sum of up to five times the annual gift tax exclusion, known as accelerated gifting, potentially reducing your taxable estate.

The New Changes for 2024: Expanding Flexibility! The recent SECURE Act 2.0 introduced a significant change for 529 plans. Starting in 2024, account owners can utilize excess funds to jumpstart beneficiaries’ retirement by transferring them directly to a Roth IRA (up to $35,000 over several years). This option allows for potential tax-free retirement savings and avoids penalties for nonqualified expenses. Funds left over can also be transferred to other family members.

While there are considerations and limitations, such as maintaining a 15-year-old 529 plan and adhering to Roth IRA contribution limits, this change opens doors for a more diversified approach to long-term financial planning.

It’s crucial to stay updated as lawmakers provide further guidelines and individual states establish their specific rules for rolling over excess 529 plan funds.

At Kowal Financial Advisors, we’re here to assist you in navigating the new landscape of 529 plans and educational planning. From optimizing education savings to identifying tax-efficient strategies, we’ll help you pave the way for a brighter future for your loved ones.

Jason entered the financial planning industry in 2013. He graduated from Radford University with a degree in finance and a minor in psychology. Jason has been on Jan’s team since 2017 and is committed to providing the best financial planning advice and services for our clients. He holds the Chartered Retirement Planning Counselor designation. Jason enjoys music, backpacking, hiking, travel, and time with his family.

Share This Story, Choose Your Platform!

Subscribe to our free newsletter.

Get the latest tips and information.

Ready to meet?

Call us today at (571) 800-0872