Our oldest daughter, Maeve, heads off to college this week. Jill and I are very proud of her, and you know, I really am going to miss that kid. It is also hard to believe that her two sisters will be following before too long. Like every American parent, Jill and I are only too familiar with the skyrocketing cost of higher education. It’s not getting any better, either.
Luckily, our government also understands the financial burden that a college education entails and have authorized a savings vehicle designed for just this – known as a 529 plan. These plans are popular with Americans, and total investments in 529 plans hit record highs last year, topping $382.9 billion, according to the College Savings Plan Network. It turns out that there were 13.6 million 529 accounts by the end of the first half of 2018 with the average size of those accounts hitting an all-time high of $24,153. Still, fewer than half of American families have 529 accounts, which leaves a lot of room for improvement.
Jen and I encounter a lot of questions from folks about 529 plans – how they work, how the funds may be used, and how much can be contributed. Some folks don’t know that the law changed last year that gives 529 plan holders more flexibility than ever when it comes to paying for education.
So, let’s spend our time this week to talk about 529 plans. There’s a lot to unpack, so let’s get started with some 529 plan basics so you can help make the best decisions for your family’s college needs.
First a little history. “Qualified Tuition Programs,” or 529 plans, were created by the Small Business Job Protection Act of 1996. The law provided the creation of these tax-advantaged accounts to help fund the education expenses of a designated beneficiary. That beneficiary can be a child or grandchild, a spouse, or even yourself. Anyone can set up a 529 plan and can name anyone else as a beneficiary. And there are no limits to the number of plans you can set up. However, there are limits to how much you can contribute and subsequently withdraw from them.
529 plan contributions are made with after-tax dollars, so contributing to one does not reduce your taxable income. There are other tax benefits, though. Here in Massachusetts, for example, 529 plan holders are eligible to claim a tax deduction on contributions of up to $1,000 per year (for individuals, $2,000 for married couples filing jointly). In addition, earnings within the plan accumulate on a tax-deferred basis.
The IRS also considers contributions made to 529 plans to be gifts for tax purposes, and 2019 gift tax exclusion limit is $15,000 (up $1,000 from 2018). That means you can deposit up to $15,000 in each beneficiary’s 529 plan (or $30,000 with a spouse) without suffering gift-tax consequences.
Some individuals use this gift-tax exclusion to contribute up to $75,000 to 529 plans, as long as they treat the contribution as if it were spread out over five years. This five-year tax gift averaging technique can be an appropriate advanced-tax planning strategy for some families looking to shelter assets from estate taxes.
Distributions used for qualified educational expenses are income tax and penalty-free. Qualified education expenses include tuition and fees, books and supplies, computers and internet access, and room and board. It’s important to note, however, that distributions from 529 plans may not exceed the amount necessary to provide for the beneficiary’s actual education expenses. Distributions used to pay for non-qualified expenses are subject to income taxes and a 10% penalty. To help prevent this, the IRS does allow plan holders to change beneficiaries to another member of the family and may roll over funds from a 529 plan to another member of the family with no tax consequences.
Generally speaking, there are two different types of 529 plans – college savings plans and prepaid tuition plans. College savings plans allow you to invest in mutual funds which are targeted for maturity as the beneficiary reaches college age. Prepaid tuition plans allow you to prepay for tuition at designated colleges and universities at today’s prices, thus providing a bulwark against inflation and rising tuition costs (which have historically dramatically outpaced inflation’s rise). If a prepaid tuition plan beneficiary elects not to go to a designated college, they may use the tax-free savings and earnings they’ve accrued to pay for tuition at a different college, but they’ll pay current tuition rates instead.
Here in the Bay State, the Massachusetts Educational Financing Authority (MEFA) administers the U.Plan Prepaid Tuition Program and the U.Fund College Investing Plan (managed by Fidelity Investments). The U.Plan program is accepted at more than 70 colleges and universities throughout Massachusetts. The U.Fund program is accepted by any college in the country. 529 plans exist around the country, so shop around for the best deal.
A couple of important aspects to the tax code have changed under the Tax Cuts and Jobs Act implemented in 2018. The one that’s gotten the most headlines is that distributions from 529 plans may now be used to pay for a total of up to $10,000 of tuition per year at elementary or secondary public, private, or religious schools. If your child or grandchild has a 529 plan for college, but it looks like they need it for tuition earlier, that can happen now without penalty.
The second change enables funds to be rolled over from a designated beneficiary to an ABLE account. ABLE (Achieve a Better Life Experience) accounts were created in 2014 as tax-advantaged savings accounts to help individuals with disabilities and their families to save and pay for disability-related expenses. The IRS only clarified last year that 529 plans were able to have funds rolled over in this manner. Be aware that rollovers may not exceed the annual ABLE contribution limit of $15,000 for 2019.
Folks, one of the inherent benefits of 529 plans is that they offer you an opportunity to plan for college for your children or another loved one, by investing and saving, or by locking in lower tuition rates and insulating yourself from the effects of inflation.
Planning for your kid’s college is not easy…I get it. I have one on her way with two to follow. Heck, planning for retirement is even harder. But remember, a plan is just a plan unless you make a decision to execute and follow through on it. Make sure to seek independent financial advice to ensure you’re making the most appropriate decision based on your family’s needs.
Be vigilant and stay alert, because you deserve more.
Have a great week!
Jeff Cutter, CPA/PFS is President of Cutter Financial Group, LLC, an SEC
Registered Investment Advisor with offices in Falmouth, Duxbury, Mansfield & Southlake, TX. Jeff can be reached at jeff@cutterfinancialgroup.com.
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