What is a 529?
A 529 is a “qualified tuition plan” authorized by section 529 of the Internal Revenue Code. According to the SEC, it’s “a tax-advantaged savings plan designed to encourage saving for future college costs.” In other words, it’s a vehicle used to help save money for college. (Beyond the scope of this article, but it always pays to remember that the earlier you put money away, the longer it has time to grow and benefit from compounding interest!)
How does one participate in a 529?
An individual can open an account within their respective state or via another state-sponsored 529. That person will be considered the owner of the account. To complete the creation of the account, there needs to be a beneficiary. This named person can be changed.
Once the account is established, anyone can contribute, i.e., friends and relatives. The contribution amounts are currently limited to the federal gifting exemption in 2017, which is $14,000. So let’s say, for example, Michael and May open a 529 account and make their son Peter the beneficiary. Michael and May can invite all their relatives and friends to contribute up to $14,000 each into Peter’s 529 account in 2017. In fact, the IRS even allows a five-year contribution at one time. If Peter’s dad wanted to help jumpstart his 529 account, he can place $70,000 in the 529 right away (five times $14K). If Peter’s dad does this accelerated funding, the IRS would not allow him to contribute again for five years.
What are the benefits of a 529?
There are two types of 529 benefits. One is available to anyone who participates in a 529 in the United States. The second type of benefit is state specific.
- Earnings (otherwise known as investment growth) in a 529 will not be subject to federal or state taxes.
- Qualified distributions (money taken out of 529 and used for approved college expenses) will not be subject to federal or state taxes.
State-Specific Additional Benefits:
- Over two dozen states offer partial or complete deductions or credits for the money placed in a 529 account. For example, New York State offers a $5,000 credit for the first $5,000 contributed into a New York State 529 account. Unfortunately, as of February 2017, the state of New Jersey doesn’t offer such a perk.
- Although many states allow non-residents to participate in their 529 program, state residents may receive slightly better terms, such as lower fees.
- Some states, such as New Jersey, offer creative incentives—such as arranging that the first $25,000 from the 529 in New Jersey not be counted in the total amount used to apply for New Jersey financial aid.
- Each state has a different lifetime account limit. For example, the state of New Jersey limit is $305,000; Utah’s limit is $430,000 and Michigan’s limit is $500,000. This means that once the account reaches the limit between contributions and investment growth, the account may no longer accept additional contributions.
Who is eligible to participate in a 529 account?
Anyone can open a 529 account as long as the person is over 18 years old and has a social security number—even a corporation. There is no income limit to owning a 529. An individual may contribute $14K to multiple 529 accounts for different beneficiaries. Also, there is no limit as to how many 529s a person can open. Let’s say Michael and May have a wealthy nephew, Sam, who lives in New York and wants to open a 529 account for their son Peter. Instead of opening one 529 for Peter, Sam decides to open up two. He opens one in New York (where he lives) and contributes $5,000 to benefit from the state 5K credit. Then Sam opens a 529 in New Jersey so Peter’s family can benefit from whatever New Jersey has to offer.
Just to be clear: the owner and beneficiary do not need to be related or even know each other. So, back to our example from earlier with Peter’s wealthy cousin, Sam—now he decides to open a 529 account for each of his 12 cousins and their best friends (whom he never met!). He can open as many as he wants and may contribute up to $14K into each account.
What if my child doesn’t go to college?
If “Peter” our beneficiary doesn’t go to college, the owners of the 529 may reassign the beneficiary to another qualifying member of Peter’s family. The other option is the owner of the 529 may decide to close the account and take an unqualified distribution. (This action will trigger a tax liability and 10 percent penalty on the earning of the principal—money put into the account. In addition, if the owner benefited from a state tax deduction or credit, that “financial benefit” will need to be returned to the state sponsor.)
For a list of qualified 529 expenses and eligible 529 schools go to YaishFinancial.com/Studentloans
I decided to skip over two important matters related to 529s in-depth, but still wanted to mention them briefly. The first is the tax consequences once the money is distributed to the eligible education institution. (There are various strategies regarding who should distribute the funds and when to distribute the monies.) The second is the investment options and considerations involved in deciding which 529 sponsor is the best match. As always, I recommend seeking legal, tax and financial advice from professionals in their respective disciplines.
By Ronn Yaish
Ronn Yaish is wealth adviser and CEO of Yaish Financial Service,s a New Jersey-based investment and wealth management firm. Ronn earned a master’s in education and an MBA in finance. He has been featured in Forbes, AOL Finance, Credit.com, GoBanking and US News and World Report. His goal is to educate and help clients “keep things simple” when managing their money.