What You Need to Know About 529 Plans
What is a 529 plan?
A 529 plan is a tax-advantaged account that allows you to save money for educational expenses used by yourself or your children. The account is funded with after-tax contributions, grows tax-deferred, and is tax-free upon withdrawal from the account when utilized for qualifying education expenses.
Who can contribute?
There are no income restrictions on who can contribute to a 529 account, which means that the answer to this question is pretty much anyone! Often grandparents will contribute to this type of account for their grandchildren and parents.
How much can be contributed?
Regarding contributions, it is best to think about annual versus aggregate limits. The aggregate limit is set at the state level, and this is the total amount that can be contributed to a beneficiary account from all sources. This is typically much higher than the cost of a 4-year education and usually irrelevant for planning purposes (for example, $540,000 in South Carolina). The more important consideration is how much to contribute annually per beneficiary. Technically speaking, 529 accounts do not have annual contribution limits; however, it is best practice not to exceed $18,000 per beneficiary if you are single (in 2024) or $36,000 per beneficiary if you are married filing jointly (in 2024) to avoid the gift tax.
What is the gift tax and what does front-loading the 529 mean?
All contributions to 529 plans are considered gifts for federal tax purposes. Each year, there is an inflation-adjusted limit to how much can be gifted before your contributions count against your lifetime gift tax exclusion. In 2024 this is $18,000 for a single person and $36,000 for a married couple filing jointly. For most people, the gift consideration does not come into play because most people contribute far less than this each year. Remember, these figures are per beneficiary per year, so if a married couple had 4 children, they could contribute $144,000 ($36,000 per beneficiary) each year and not be concerned about the gift tax exclusion. For those who may have estate planning concerns but want to contribute substantially to a 529 account, you may “front load” contributions to accomplish this goal. This allows you to place 5 years’ contributions up to the gift limit in one calendar year “up front.” For example, a married couple could put $180,000 upfront in a child’s account if they are not contributing further in the next five years without triggering any considerations for gift limits.
Do I get a tax deduction for contributing to a 529 plan?
The answer for federal taxes is no, but many states provide a tax deduction for contributions to a 529 plan. South Carolina allows 100% of contributions to be deducted on your state tax return. If you contribute to another state’s 529 plan but live in South Carolina, you do not qualify to deduct this from your South Carolina taxes.
How is the money invested?
You can choose from a variety of risk tolerances and investment portfolios inside a 529. A discussion with your financial planner can help you determine what might be best for you and your family. You can make changes to these elections at any time.
What if my child doesn’t go to college?
You may make beneficiary changes at any time to include other children, members of your extended family, or even yourself. Remember that 529 funds can be used for specific apprenticeship and trade programs. The SECURE ACT 2.0 passed in December 2022 allows you to roll over unused 529 money for a beneficiary as long as the account has been open for 15 years. The funds rolled must not have been contributed in the past 5 years, and the rollover is subject to both earned income rules that apply to opening a Roth IRA, yearly funding capped at $6500, and a lifetime limit of $35,000. The Roth IRA must be for the named beneficiary of the account. Practically this means you could open your 529 when your child is 1 year old and, at age 16, begin rolling out contributions into a Roth for them that would be subject to income they earn in subsequent years and not to exceed $6500 per year. Under this scenario, they could have $35,000 (plus earnings) in their account by age 20.
529 Funding and Student Aid
The new FAFSA for 2024-2025 will change how students report income so that grandparent-held 529 funds will not penalize them as before this change. Now is an excellent time for parents and grandparents to get on board with funding these accounts.
Conclusion
In summary, when it comes to educational savings, it is hard to find a better more versatile account than the 529. This is an area of concern for many of our clients and projecting college savings is part of our overall financial planning process at Brightworks.
