CCPA: 529 Plans - QTP Basics & Benefits FAQ
A Qualified Tuition Plan (QTP or 529 Plan) can be a tremendously beneficial tax savings tool. Let’s take a look at some of the basics as we round out 2024!
What is a 529 Plan?
In general, a 529 plan is a tax-advantaged savings plan (authorized by Section 529 of the Internal Revenue Code) that is sponsored by states, state agencies or educational institutions. It is intended as a means for helping families save for and pay college tuition as well as primary and secondary education costs (K-12 with a $10,000 per year/per child max). Plan funds can also be used to pay student loan principal and/or interest on a student loan (up to $10,000 per person). A 529 Plan can be established by anyone – parent, student, grandparent, friend – and you can contribute to a 529 Plan in any state even if it differs from your state of residency.
Why is it beneficial for tax purposes?
First, earnings on funds deposited in the plan will accumulate tax free while in the account = no capital gain income on any appreciation – similar to many retirement accounts.
Distributions (including the appreciation in value) aren’t taxable as long as they are solely used for qualified education expenses (read more on the IRS’s FAQ to see which expenses these are, and check with us if you’re unsure).
While contributions are not tax deductible for Federal tax purposes, many states allow a deduction for some/all of the contribution amounts on your state income tax return. This can save you on your state income tax liability.
Are there contribution limits to consider?
The IRS doesn’t specify a hard-line limit on amounts that can be contributed annually or in total, though most states DO have limits so you should be sure to brush up on the rules where you are). All the IRS establishes is that the amounts contributed for each beneficiary can’t be more than the amount reasonably necessary to pay for school or college. So, you will need to stay mindful of your account balance across all 529’s for each student and be aware of any State-imposed overall contribution limits (these most recently have been anywhere between $235,000 and $500,000).
Typically, to avoid getting into Gift Tax complications, annual contributions per beneficiary are recommended to stay at or below the annual gift tax exclusion limit. For 2024, this amount is $17,000 ($34,000 per couple filing jointly).
There are ways to lump sum fund, or superfund, plans but this will necessitate the filing of annual Gift Tax returns and have additional planning considerations.
Additional Considerations
While 529 Plans offer significant tax advantages with tax free appreciation on capital gains, there are potential downsides to consider. One major drawback is that the funds must be used for qualified education expenses; if they are not, the earnings portion of any withdrawal will be subject to federal income tax and a 10% penalty. Additionally, investment options in 529 Plans can be limited compared to other savings vehicles, and returns are not guaranteed, meaning you could lose money. Another concern is the impact on financial aid eligibility, as the value of a 529 Plan can be considered when determining aid. Lastly, contributions to a 529 Plan are irrevocable, so once the money is in the account, it must be used for the beneficiary or transferred to another family member, limiting flexibility.
There is a limited exception to the 529 qualified education expense requirement introduced by the Secure Act 2.0. A new provision under the SECURE 2.0 Act allows for the rollover of 529 Plan funds to a Roth IRA, subject to certain conditions. This offers more flexibility if the funds in a 529 Plan are not needed for education expenses. Here are the key details of the rollover:
Lifetime Cap: The total amount that can be rolled over from a 529 Plan to a Roth IRA is capped at $35,000 over the beneficiary’s lifetime.
Plan Age Requirement: The 529 Plan must have been open for at least 15 years before any rollovers can occur.
Contribution Timing: Contributions (and earnings on those contributions) made to the 529 Plan in the last five years are not eligible for rollover to a Roth IRA.
Annual Roth Contribution Limits: The rollover is subject to the annual Roth IRA contribution limit, so you cannot exceed that amount in a given year through the rollover.
This new rule provides a beneficial option for families who may have excess funds in a 529 Plan and are concerned about the potential tax penalties for non-qualified withdrawals.
As with most everything tax-related, there are multiple levels of income, estate and state tax considerations to dig into before charging ahead and setting up a 529 plan. So, if this article has piqued your interest in learning more about 529 Plans and how you might be able to reap the benefits of one, please reach out to your tax or investment advisor for more detailed information and next steps. Our friends at Harmony Wealth Advisors also have a handy deep dive primer and handy college saving checklist over on their blog this month.
As always, follow the Harmony blog and our newsletter for more year end tips and breaking news.