Don't Mess With Taxes

Students, and their families, have a lot to worry about. 529 plan savings can help ease some of the financial concerns. (Photo via Unsplash+ in collaboration with Andy Quezada)

Happy 529 Day!

OK, it’s not an official holiday. It was started in 2021 by National Day Calendar and College Savings Foundation (CSF), and is one of the many commemorations that fill up the 365 days, 366 in Leap Years, of each year.

Some of the special days are, to my thinking, downright goofy, although I do believe ice cream deserves to be celebrated every single day. But some merit serious consideration.

National 529 Day is one of those worth the added attention. It is celebrated on May 29th each year to raise awareness of 529 plans, which can help students and their families cover certain college and other educational costs.

The 529 name is not because the plan was created, back in 1996, on May 29 (or 5/29 in numerical shorthand), but from the Section 529 of the Internal Revenue Code (IRC) that authorizes the savings option.

And while Uncle Sam’s tax code sanctions the plans, 529 plans and are sponsored by states, state agencies, or educational institutions.

In some states, 529 Day is celebrated with special promotions and contests. In most cases, however, May 29 is used as a day to remind potential 529 plan beneficiaries of the value of the plans and encourage them to open or add to the savings.

Here at the ol’ blog, we’re going to focus on a few more 529 plan facts than just the highlights cited earlier.

1. Federal and state tax advantages. The U.S. tax code is involved because 529 plans have several tax advantages. At the federal level, you don’t get a federal tax break on your Form 1040 for contributions to a 529 plan. But money you do put into a 529 grows free of any federal taxation. Even better, withdrawals also are federally tax-free when they're used to pay for qualifying college expenses.

Most states also allow tax-free 529 plan withdrawals to pay for qualified expenses. And in states with a personal income tax, which is most of them, you might be able to get a tax break for the money you put into this special educational savings plan. States allow either a tax deduction from state income or a state tax credit for 529 plan contributions at tax return filing time.

2. Three types of 529 plans. While the term 529 plan generally is used in discussing the savings option, there actually are two types of 529s. There is the education savings plan, which is the most popular version, and a prepaid tuition plan.

Through a 529 savings plan, which really is an investment account, you contribute to different types of portfolios offered by the plan. Keep in mind that as an investment vehicle, a 529 plan has both the benefits and drawbacks of such financial choices. Fees and expenses  — ranging from an enrollment/application fee to annual account maintenance fees to continuing program and/or asset management fees — associated with plans will lower your returns.

With a prepaid tuition plan, you buy credits for tuition, usually at a specific state college or state college system, at today's prices. If the student for whom the 529 was created attends a different university or doesn't attend college at all, you may not get back the full value of the credits. Prepaid plans also may charge an enrollment/application fee and ongoing administrative fees.
    

 
There also is a similar tax-advantaged educational savings program, known as a 529A account, to help people with disabilities save money for college and other expenses. These plans were authorized by the Achieving a Better Life Experience (ABLE) Act of 2014. Like the original 529 plans, 529A earnings and distributions are tax-free to the beneficiary student if used for eligible educational expense. However, contributions to ABLE accounts aren't deductible for federal tax purposes.

Savingforcollege.com has an interactive U.S. map with details on the available 529 plans that can help you decide, or at least narrow down your choices. The website also has online tools to help you compare 529 college savings plans.

A note for Wyoming residents. The Cowboy State is the only one that doesn't offer its own 529 plan. It has, however, partnered with Ohio to create WYABLE, a 529A program, for eligible Wyoming residents.

3. Age, income, and school rules. Unlike many tax provisions, you don't have to worry about income limits when contributing to a 529 plan. Regardless of how much you make, you can put money into one of these savings plans.

Similarly, age is not an issue. Anyone, be they young or simply young at heart, who plans to attend an eligible educational institution can be the beneficiary of a 529 plan.

Those eligible institutions include public, private, religious, or vocational schools. 529 plans assets also can be used toward K–12 tuition or fees of up to $10,000 per student per year. The funds also can be used in some cases to pay make student loan payments.

4. Qualifying educational expenses. You've got the plan. Now you want to spend the money. To ensure that you maintain the tax-free status of 529 funds, be sure to use them only for Internal Revenue Service approved school expenses. These so-called qualified expenses include tuition, required fees, books, and supplies related to enrollment and classes, including required trade tools for registered apprenticeships. Other qualifying costs include computer equipment and related technology as well as internet services, and certain expenses for a special-needs student.

When someone is at least a half-time student, room and board also qualifies. Room and board costs can also include rent for off-campus residencies — apartments, rental homes, and fraternity/sorority houses — and groceries (non-taxable items only), provided these costs are equal or less than the school’s room and board allowances.

5. 592 uses beyond education. What if the student for whom the 529 plan was opened decided not to go to college? You can change the account beneficiary anytime as long as the new student is a qualified family member. This includes a sibling, stepchild, or parent who has plans to attend university.

And if you are/were a diligent 529 saver, a provision in the Setting Every Community Up for Retirement Enhancement (SECURE) Act 2.0, allows some excess account funds to be converted to retirement savings. 529 account owners can incrementally roll over, tax- and penalty-free, a lifetime maximum of $35,000 (following annual rollover limits) to a Roth IRA for the beneficiary.

Now that you know a bit more about 529 plans, it's time to celebrate. Since, as noted earlier, I’m the big ice cream fan, I'll bring that frozen treat if you'll bake the cake.

You also might find these items of interest:

• A quick lesson on 8 education tax breaks
• Extra RMD money could make a good 529 plan gift
• 7 financial gifts, some with tax benefits, for graduates

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