10 Most Common Questions About 529 Savings Plans

A 529 Savings Plan is a tax-advantaged account used to pay for qualified education expenses. Contributions are typically invested in target-date funds, which gradually shift toward a more conservative allocation as the beneficiary nears college age.

You may be considering a 529 for your child, grandchild, or another family member. Here are some of the more common questions we hear from our clients regarding 529 accounts. Read here or continue below:

1. What are the tax advantages of 529 Savings Plans?

529 plan contributions and earnings grow federal and state tax-free, provided withdrawals are used to pay qualified expenses.

Contributions to 529s are not tax-deductible for federal purposes. However, there may be some state tax benefits depending on the plan and income tax rules for the state corresponding to the 529 plan.

2. What expenses are eligible to be paid from a 529?

Qualified education expenses include:

• College tuition
• Room and board (subject to limits set by the college)
• Mandatory fees, plus any required material for classes (such as books or computers)
• Tuition and qualified expenses of apprenticeship programs
• Studying abroad (typically)
• $10,000 a year for K-12 tuition costs (for certain states only)
• A lifetime maximum withdrawal of $10,000 to pay down student loan debt
• Roth IRA contributions for the beneficiary (up to $35,000 lifetime limit)

Generally, we recommend using 529s to cover higher education expenses. The beneficiary will benefit from compounding years of tax-deferred growth the longer the funds remain invested in the account. If the 529 plan account balance exceeds the estimated amount of college expenses or if costs will be covered by another means, then we may recommend using the plan to cover K-12 tuition.

For a complete list of 529-eligible universities in the U.S. and abroad, visit http://www.savingforcollege.com/eligible_institutions/

3. Which 529 Plan should I use, and is there a benefit to using my state’s plan?

Each state has its own 529 plan, so the answer varies depending on where you live and the quality of the plan. Over 30 states, including Oregon, offer a state income tax credit or deduction for 529 plan contributions. To see a summary of the different state tax benefits, visit https://finaid.org/savings/state529deductions/

While most states require their own plan to be used to receive the tax benefit, there are currently seven states, including Arizona, that provide residents with tax benefits for contributions to any state plan. In most of these states, anyone who contributes to a 529 plan is eligible for the tax benefit. However, there are six states that limit the tax benefit only to account owners and their spouses.

Washington and California offer residents no state tax incentives for 529 contributions, so residents are free to use any state plan of their choosing.

4. What happens if funds are withdrawn for non-qualified expenses?

Typically, there would be an income tax and 10% federal tax penalty on plan earnings.

5. What happens to the 529 account if the beneficiary gets a scholarship?

529s may be used to pay expenses not covered by the scholarship, such as books and supplies. Plan assets can also be used for post-graduate education, or they can be transferred to a relative of the beneficiary to pay for their higher education expenses.

If you have leftover funds, you can withdraw up to the amount of the scholarship without penalty, but you will have to pay income tax on any investment gain. In this case, you might consider having the 529 distributions paid to and reported by the student, as they are potentially in a lower tax bracket. However, this strategy requires changing the ownership of the 529 account, which may have tax implications.

6. Do I need to keep records of the 529 withdrawals for my taxes?

We recommend clients retain receipts to document the withdrawals were spent on qualified expenses in case of an audit. However, for tax preparation and withdrawals from the 529 plan, this proof is seldom needed. Furthermore, to ensure that receipts match up easily, we recommend withdrawing funds from the 529 in the same tax year your costs were incurred.

7. Does it matter who is named as the account owner?

The person establishing the account is listed as the owner, receives account statements, and manages the investments. Withdrawals will be reported on the owner’s tax return. However, anyone can make contributions to the account.

It is important to note that ownership of the account will impact financial aid calculations under the FAFSA process, which determines a family’s ability to pay for college before receiving any awards. Under FAFSA, a family is expected to contribute a certain percentage of assets owned by parents, while assets owned by nonparent family members (such as grandparents, aunts, uncles, etc.) do not impact the calculation. However, nonparent 529 plans are still considered part of the CSS Profile, which is used by private colleges and universities to award financial aid. Click here to calculate your current Expected Family Contribution (EFC) under FAFSA rules.

It may be possible to avoid the higher assessment by switching ownership away from the parents before withdrawals begin or waiting until the final years of college to use the assets in the parent-owned 529. Be sure to check your plan’s rules before opening the account.

8. Can I change the name of the beneficiary on my 529 Plan?

Yes, most plans allow transfers to a “member of the family.” For instance, if a couple’s oldest child receives a scholarship, they could reassign funds to anyone else related to the child, such as siblings (including a stepbrother or stepsister), parents, grandparents, first cousins, aunts, and uncles.

9. Is there a limit to how much I can contribute to a 529?

Yes, the limit varies by state and can range from $235,000 to $550,000. We typically recommend spreading plan contributions over several years to stay within the annual tax-free gifting limits to avoid filing a gift tax return. Click here for current gift exclusion amounts.

Note: 529 plans do allow a special one-time contribution worth up to five years of annual gifts. This would require filing a gift tax return, but no gift tax would be incurred.

10. What other strategies are available if I am concerned about overfunding a 529 Account?

You can continue to save and invest within your own taxable account. Consider gifting appreciated securities to adult children who are attending college or graduate school. If they are in a low tax bracket, they may be able to sell the stock without paying capital gains tax.

As with any investment, it is important to consider how a 529 savings plan and other education funding strategies fit in with your broader financial and tax planning. If you would like to discuss your options for education funding, your Coldstream team can help you get started.

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Disclaimer:  This article has been provided for informational purposes only and should not be considered as investment advice or as a recommendation. This material provides general information only. Coldstream does not provide any specific tax or legal advice; you should consult your tax, legal, or other advisors before implementing any changes to your current financial situation.

To ensure compliance with requirements imposed by the IRS, we inform you that any federal tax advice contained in this communication (including attachments) is not intended or written to be used and cannot be used for (1) avoiding penalties imposed under the Internal Revenue Code or (2) promoting, marketing or recommending to another party any transaction or matter addressed herein unless the communication contains explicit language that it is a tax opinion in compliance with IRS requirements.  Please contact your tax advisor for guidance on your individual situation.