Give the Gift of Education With 529 Plan Contributions
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 as long as the funds are spent toward qualified education expenses.
Historically, 529 plans have funded college tuition and room and board expenses. Recent legislative changes now allow 529 plans 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. 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.
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 2022, gifts totaling up to $16,000 per individual will qualify for the annual exclusion. This means if you and your spouse have three grandchildren you can gift $96,000 ($32,000 per grandchild) without gift-tax consequences, since each child can receive $16,000 in gifts from you and $16,000 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 $80,000, or $160,000 per couple, to a 529 plan without incurring gift taxes. This is absolutely true, and some may consider “front-loading” a 529 plan to gain the advantage of compounding. The advantage of front-loading becomes clear when you compare the savings outcome with regular annual contributions:
- If you contribute $80,000 over 18 years in annual installments of $4,444, the total would be just $125,020 if compounded at a hypothetical growth rate of 5%.
- If you front-loaded a plan with $80,000, and let it compound annually for 18 years at a hypothetical growth rate of 5%, it would compound to $192,530 - $67,510 higher!
Impact of 529 Plan on Financial Aid
In general, 529 plans are considered a parent asset on the Free Application for Federal Student Aid (FAFSA) and this has a relatively small effect on financial aid eligibility. When a grandparent or family member owns a 529 plan, it is not counted on the FAFSA form until withdrawals occur, at which point it is considered income to the student and can reduced a student’s eligibility for federal financial aid by 50% of the amount withdrawn. However, there is current legislation pending (FAFSA Simplification Act) which will eliminate the requirement that students report income from non-parent sources. It is anticipated that this change will go into effect with the 2024-2025 school year. This will be a big opportunity for grandparents and family members to step up support for education without impacting financial aid. In the meantime, students can still draw from non-parent owned 529s in the last two years of college and avoid a detrimental impact on financial aid eligibility.
I Series Savings Bonds
Another investment vehicle for college savings to consider in today’s market is the I Series U.S. Savings Bond. Like many of the Treasury’s savings bond products, I bonds are considered zero-coupon bonds. Interest is not paid out, but rather added back to the bond and compounded until you sell the bond back to the U.S. government. Interest on the I bond is calculated in two parts: a fixed rate that stays with the bond for its interest-earning life (30 years) and a semi-annual variable rate that adjusts with changes in inflation as measured by the Consumer Price Index (“CPI”). The concept is that I bonds will always beat inflation by a small amount.
One of the benefits of I bonds is that as interest compounds, you can defer the taxes on it until it is sold. And, an additional benefit is that I bonds qualify for the government’s Education Savings Bond Program. You won’t owe taxes ever if used for qualified educational expenses – tuition, lab and course fees, and degree-required courses. Unfortunately, room and board, technology, and activity fees do not qualify, but can be covered by 529 plans. Given their current interest rate of 9.62% and potential tax-free status when used to cover college tuition, I Bonds can work well in conjunction with a 529 plan.
The only downside to I Series bonds is that the maximum any individual can buy in one calendar year is $10,000. So I bonds should be considered as a supplement to a 529 plan for education expenses.
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.