A 529 plan is a tax-advantaged investment account originally designed to help families pay for college. The earlier you start saving, the greater you will benefit from tax-free compounding. Withdrawals from these plans are tax-free if the funds are spent toward qualified education expenses.
Historically, 529 plans have funded college tuition and room and board expenses. More recently, 529 plans are allowed to pay for up to $10,000 per year of private school tuition for grades K-12, and up to $10,000 per beneficiary (and their siblings) for student loan repayments. With the SECURE 2.0 Act, starting in 2024, 529 account owners can roll over up to an aggregate lifetime limit of $35,000 from a 529 plan into a Roth IRA for the benefit of the 529 plan beneficiary (see below) These changes make 529 plans even more appealing as a vehicle to help support educational goals within a family.
Given the rising cost of a college education, many grandparents and family members are looking to help contribute to education expenses for their grandchildren and relatives. While it is possible to pay tuition to universities directly and be exempt from gift taxes, this exemption only applies to tuition payments, and non-tuition expenses can comprise up to 50% of total expenses for college students. Opening a 529 plan for a child enables a grandparent or family member to cover a broader range of expenses and allows for tax-free investment growth.
Fidelity has some nice offerings and features that can help with savings goals:
- Fidelity has a 529 College Gifting Dashboard which allows family and friends to give online for birthdays, holidays, or other milestones to help achieve college savings goal.
- Fidelity also offers a 529 College Rewards Visa Signature Card where you can earn unlimited 2% cash back on every eligible net purchase.
How Much Can You Contribute Annually?
While the IRS doesn't specify annual contribution limits to 529 plans, there are some rules you should be aware of if you're considering making a large deposit this year:
- Annual gift tax exclusion: In 2023, gifts totaling up to $17,000 per individual will qualify for the annual exclusion. This means if you and your spouse have three grandchildren you can gift $102,000 ($34,000 per grandchild) without gift-tax consequences, since each child can receive $17,000 in gifts from you and $17,000 in gifts from your spouse. In addition, once the funds are deposited into the 529 plan, they are outside of your taxable estate.
- The 5-year election: You may have read that an individual can contribute as much as $85,000, or $170,000 per couple, to a 529 plan without incurring gift taxes. This is commonly referred to as “super funding” a 529 plan. This is absolutely true, and some may consider “front-loading” a 529 plan to gain the advantage of compounding.
How do 529 Plans affect Financial Aid?
Many families worry that saving for college will hurt their chances of receiving financial aid. But, because 529 savings plan assets are considered parental assets, they are factored into federal financial aid formulas at a maximum rate of about 5.6%. This means that only up to 5.6% of the 529 assets are included in the expected family contribution (EFC) that is calculated during the federal financial aid process. That's far lower than the potential 20% rate that is assessed on student assets, such as assets in an UGMA/UTMA (custodial) account.
One important caveat is the difference in treatment if someone other than the parents or student—such as a grandparent—owns the 529 plan. In that case, while these 529 savings are not reported as a student asset on the Free Application for Federal Student Aid (FAFSA), any distribution from this 529 plan is reported as income to the beneficiary. The FAFSA typically looks at income two years back so the distribution from a grandparent 529 could result in a reduction in eligibility in the year after next.
For example, say the original child for whom the account was set up chooses not to go to college—or doesn't use all the money in the account—the account owner can then transfer the unused money to another named beneficiary.
New 529 Rules with SECURE 2.0 Act-Rollover to a Roth IRA
Currently, a 529 plan withdrawal for anything other than qualified education expenses may be subject to income tax and a 10% penalty. Starting in 2024, 529 account owners can roll over up to an aggregate lifetime limit of $35,000 from a 529 plan into a Roth IRA for the benefit of the 529 plan beneficiary. The rollover is subject to the $6,500 per year rollover limit and must be in the same name as the 529 plan beneficiary. The 529 plan must have been in existence for at least 15 years prior to the rollover and any 529 contributions made within the last 5 years are ineligible.
This is a snapshot of the issues around using 529 plans to fund education expenses. If you would like more information or have any questions, please don’t hesitate to reach out to our offices directly.
Sources: Fidelity, Forbes, Savingforcollege.com