HIGHLIGHT: 529 PLANS

May 29, 2020

A college education is one of the largest and most important investments you’ll ever make.  Unfortunately, the cost of this investment has risen rapidly, illustrating the downside of the “Miracle of Compound Interest.”  The average annual cost of college in the US for the 2019-2020 school year rose 3.4% to $36,880. Student debt is a $1.5 trillion crisis, with recent graduates owing an average of $40,000 of soul-crushing debt.

With college costs escalating rapidly, reducing future debt by starting to save as much and as soon as you can for a child’s college education is vitally important.

Authorized under Section 529 of the Internal Revenue Code, 529 College Savings Plans are offered by virtually all 50 states to encourage parents and loved ones to save for a child’s education.  These plans offer tax-free growth and some, like Indiana’s, have significant additional tax benefits for residents.

But are 529 college savings plans worth it? How do they work? What are the benefits? We’ve compiled information to help answer these questions.  In addition, we recommend visiting both www.Savingforcollege.com and www.Collegesavings.org, which offer a wealth of free, comprehensive information on 529 Plans.  You should also consult your tax adviser.

What is a 529 plan?

There are two types of 529 plans, which vary by state.

1. 529 college savings plans. A donor opens an account and names a beneficiary (the future or current college student). Funds in the account are used to pay qualified expenses of the beneficiary such as tuition, room and board, mandatory fees and textbooks.  Donors can generally open an account in any state’s 529 Plan.
2. The Private College 529 Plan is owned by 284 member colleges nationwide—12 in Indiana. It is a prepaid tuition plan (minimum initial contribution $25).  Participants purchase Tuition Certificates at current tuition rates, to be redeemed for education years down the road at any member college.  Importantly, the colleges bear the market risk and you do not have to commit to a particular college until you actually enroll and redeem your certificates.  

Basic 529 plan benefits and features

• Contributions to 529 Plans are not deductible on your federal tax return, but your investment grows on a tax-free basis.
• Distributions are also tax-free, as long as they pay for qualified higher education expenses of the beneficiary, regardless of whether the college is public or private or where it is located.
• It’s not just for college. As of 2018, up to $10,000 can be withdrawn tax-free from a 529 plan per year, per beneficiary, for tuition expenses at public, private or religious schools for grades K-12.
• You have the flexibility to change beneficiaries. If one child chooses not to go to college, you may “roll over” the funds to another child or grandchild, or even for yourself if you’re going back to school.
• As the donor, you control when withdrawals are taken and for what purpose. The beneficiary generally has no rights to the funds.
• The SECURE Act, passed in December 2019, expanded allowable uses for 529 funds. Under the new rules, up to $10,000 from a 529 account can be used to repay the beneficiary’s student loans. Plus, up to another $10,000 each can be used to pay student loans held by the beneficiary’s siblings. Additionally, the cost of apprenticeship programs was added to the list of qualified expenses.
• Ugift is an easy, free-to-use service that lets account owners suggest that family and friends celebrate children’s milestones with the gift of college savings in lieu of traditional gifts.
• Contributions to, distributions from and assets in a 529 plan may have implications for estate planning/college financial aid.  Please contact us if you’d like more information.

Indiana’s Tax Credit

In addition to the federal tax savings, over 30 states currently offer full or partial tax deductions or credits for 529 plan contributions.

Hoosiers can claim a 20-percent income tax credit–up to a maximum of $1000 per return each year–for contributions made directly to a CollegeChoice account, whether they are the account owner or not.  Make a $5,000 contribution received by 12/31/2020 and you can take a $1,000 credit on your 2021 Indiana income tax bill.  On a net basis, your $5,000 contribution costs you only $4,000.  It’s like finding a $1000 bill laying on the sidewalk, but you have to pick it up!

Information on Indiana’s CollegeChoice 529 Direct Plan (for do-it-yourselfers) is located here and Advisor Plan here.

Be sure to take the time to research all of your options.

An Important Recent Development

Tuition refund money: Families that received refunds for tuition, room and board, or other qualified expenses from colleges due to COVID-19 related disruptions have a few options.  Refunds received between February 1, 2020 and May 15, 2020 can be recontributed into a 529 plan for the same beneficiary before July 15, 2020. Refunds received after May 15, 2020 must be recontributed to the plan within 60 days of receipt.

For families that paid for college expenses using a combination of 529 plan funds and their own funds, it’s possible to keep the refund without penalty.  If their qualified educational expenses, after deducting the refund, exceed the distribution from the 529 plan, the refund can be kept without paying taxes or a penalty.  Assume a family paid $27,000 in college costs, using $20,000 from a 529 plan and $7,000 in personal funds.  Further assume they received a refund of $2,500, leaving $24,500 in qualified expenses.  Since this exceeds the $20,000 distribution from the 529 plan, the distribution is qualified even if the family does not recontribute the funds.  However, if the family had paid $25,000 from the 529 plan (and all other factors were the same), they would have to recontribute at least $500 to the plan to avoid taxes and a penalty.

This memorandum relates to general information only and does not constitute legal or tax advice. Facts and circumstances vary. We make no undertaking to advise recipients of any legal changes or developments.