This material was prepared for John Evans, LPL Financial Advisor, use.
Millions of families turn to 529 college savings plans to strive to meet the mounting costs of college.
For most investors, the plans’ main attractions are the potential for federal tax-deferred earnings growth and federal tax-free qualified withdrawals.1 The plans’ aggregate asset limits, which often exceed $200,000, also appeal to many concerned about the potential for a six-figure price tag on a four-year degree.
But a closer look at the rules governing 529 plans reveal other attractive reasons to consider this investment tool in your child’s or grandchild’s future. Benefits include:
Avoid federal gift taxes and accelerate giving
You can contribute up to $13,000 (or $26,000 if you and your spouse give and file jointly) to a 529 plan each year without owing federal gift taxes, provided you haven’t made other financial gifts to the plan beneficiary in the same year. In addition, you can elect to make a lump-sum contribution of up to $65,000 ($130,000 for married couples filing jointly) in the first year of a five-year period, provided you don’t give the beneficiary additional taxable gifts during the five-year period.2
Create an educational funding legacy
A 529 plan gives the owner control over the plan, including flexibility in naming and changing the beneficiary. The beneficiary can be any age and generally can be changed to a qualified relative when needed. For example, if the original beneficiary decides not to attend college, you can designate a new beneficiary. This flexibility may enable you to establish a college funding legacy for current and future generations. For example, you could open a 529 plan account to pay your child’s college bills. Then, if there’s money left over after he or she finishes college, you can change the beneficiary to another qualified family member and perhaps later to a grandchild.
The ability to consolidate college funding assets for one beneficiary in a single 529 plan can make management much easier. Depending on plan rules, you may be able to arrange transfers from a Coverdell Education Savings Account, a custodial account or another 529 plan without triggering federal income taxes. Be sure to review the tax implications with a tax professional, however. Transfers of assets from Series EE and I bonds may also be allowed under certain conditions.
Maximize financial aid eligibility
Money in a 529 account is usually considered by colleges to be the account owner’s asset, which often means the parents’ asset. As a result, a maximum of 5.6 percent of the balance is generally assumed to be available for college annually, compared with 35 percent if the assets were the student’s. With a custodial account, on the other hand, the assets are considered the student’s. And according to the Department of Education, qualified distributions from a 529 plan are not counted as parent or student income and therefore do not affect aid eligibility.
Look into state tax savings
State tax savings are another potential benefit of a 529 plan. In Iowa, for example, earnings are fully exempt from Iowa state income tax. In addition, withdrawals are exempt from Iowa state income tax when used for qualified higher education expenses.
There may be other advantages of 529 plans to consider, as well. Be sure to talk with your financial advisor and tax professional for help assessing how a 529 plan may affect your tax situation.
John Evans is Investment Services Manager at MidWestOne Bank. He specializes in investments and retirement planning.
1The earnings portion of nonqualified withdrawals is subject to federal income taxes, a 10% federal tax penalty and possible state taxes and penalties.
2If you die before the end of the five-year period, a prorated portion of the contribution will be considered part of your taxable estate.
Section 529 plans are established and maintained by state governments or agencies or eligible educational institutions. Contributions must be kept in a qualified trust in order to be treated as a qualified tuition program.
You should consider a 529 Plan’s fees and expenses such as administrative fees, enrollment fees, annual maintenance fees, sales charges, and underlying fund expenses, which will fluctuate depending on the 529 Plan invested in the investments chosen within the plan.
MidWestOne Bank and MidWestOne Investment Services are not registered broker/dealers and are not affiliated with LPL Financial.
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