Top 10: Little-Known Facts About 529 College Savings Accounts
While 529 college savings accounts seem relatively straightforward, there are a number of little-known facts about these accounts that can be used for advanced wealth planning, tax strategy, and avoiding common pitfalls when taking distributions from these college savings accounts.
While 529 college savings accounts seem relatively straightforward, there are a number of little-known facts about these accounts that can be used for advanced wealth planning, tax strategy, and avoiding common pitfalls when taking distributions from these accounts.
1: Roth Transfers Will Be Allowed Starting in 2024
Starting in 2024, the IRS will allow direct transfers from 529 accounts to Roth IRAs. This is a fantastic new benefit that opens up a whole new basket of multi-generation wealth accumulation strategies for families.
2: Anyone Can Start A 529 Account For A Child
Do you have to be the parent of the child to open a 529 account? No. 529 account can be opened by parents, grandparents, aunts, or friends. Even if a parent has already established a 529 for their child there is no limit to the number of 529 accounts that can be opened for a single beneficiary.
3: State Tax Deduction For Contributions
There are currently 38 states that offer either state tax deductions or tax credits for contributions to 529 accounts. Here is the list. There are no federal tax deductions for contributions to 529 accounts. Also, you don’t have to be the parent of the child to receive the state tax benefits.
4: A Tax Deduction For Kids Already In College
For parents that already have kids in college, if you have not already established a 529 account and you are issuing checks for college tuition, for states that offer tax deductions for contributions, you may be able to open a 529 account, contribute to the account up to the state tax deduction limit, and as soon as the check clears, request a distribution to pay the college expenses. This allows you to capture the state tax deduction for the contributions to the account in that tax year.
5: Rollovers Count Toward State Tax Deduction
If you just moved to New York and have a 529 with another state, like Vermont, you are allowed to roll over the balance of the Vermont 529 account into a New York 529 account for the same beneficiary and those rollover amounts count toward the state tax deduction for that year. We had a New York client that had a Vermont 529 for their daughter with a $30,000 balance, and we had them rollover $10,000 per year over a 3-year period to capture the maximum NYS 529 state tax deduction of $10,000 each year.
6: Not All States Allow Distributions for K – 12 Tuition Expenses
In 2018, the federal government changes the tax laws allowing up to $10,000 to be distributed from a 529 account each year to pay for K – 12 tuition expenses. However, if you live in a state that has state income taxes, states are not required to adopt changes that are made at the federal level. There are a number of states, including New York, that do not recognize K – 12 tuition expenses as qualified expenses so the earnings portion of those withdrawals would be subject to state income tax and recapture of the tax deductions that were awarded for those contributions.
7: Transfers Between Beneficiaries
529 rules can vary state by state but most 529 accounts allow account owners to transfer all or a portion of balances between 529 account with different beneficiaries. This is common for families that have multiple children and a 529 account for each child. If the oldest child does not use their full 529 balance, all or a portion of their 529 account can be transferred the 529 accounts of their younger siblings.
8: Contributions Can Be Withdrawn Tax and Penalty Free
If you ever need to withdraw money from a 529 account that is not used for qualified college expenses, ONLY the earnings are subject to taxes and the 10% penalty. The contributions that you made to the account can always be withdrawn tax and penalty-free.
9: 529 Accounts May Reduce College Financial Aid
The balance in a 529 account that is owned by the parent of the student counts against the FAFSA calculation. Fortunately, assets of the parents only count 5.64% against the financial aid award, so if you have a $50,000 balance, it may only reduce the financial aid award by $2,820. However, 529 accounts owned by a grandparent or another relative, are invisible to the FAFSA calculation.
10: Maximum Balance Restrictions
529 plans do not have annual contribution limits but each state has “aggregate 529 plan limits”. These limits apply to the total 529 balances for any single 529 beneficiary in a particular state. Once the combined 529 plan balances for that beneficiary reach a state’s aggregate limit, no additional contributions can be made to any 529 plan administered by that state. Luckily, the limits for most states are very high. For example, the New York limit is $520,000 per beneficiary.
About Michael……...
Hi, I’m Michael Ruger. I’m the managing partner of Greenbush Financial Group and the creator of the nationally recognized Money Smart Board blog . I created the blog because there are a lot of events in life that require important financial decisions. The goal is to help our readers avoid big financial missteps, discover financial solutions that they were not aware of, and to optimize their financial future.
Grandparent Owned 529 Accounts Just Got Better
A 529 account owned by a grandparent is often considered one of the most effective ways to save for college for a grandchild. But in 2023, the rules are changing………
Grandparent Owned 529 Accounts Just Got Better
A 529 account owned by a grandparent is often considered one of the most effective ways to save for college for a student. Mainly because 529 accounts owned by the grandparents are invisible to the college financial aid calculation (FAFSA) when determining the financial aid package that will be awarded to a student. But there is a little-known pitfall about distributions from grandparent owned 529 accounts and the rules are changing in 2023. In this article, we will review:
Advantages of grandparent owned 529 accounts
The FAFSA pitfall of distributions from grandparent owned 529 accounts
The FAFSA two-year lookback period
The change to the 529 rules starting in 2023
Tax deductions for contributions to 529 accounts
What if your grandchild does not go to college?
Paying K – 12 expenses with a 529 account
Pitfall of Grandparent Owned 529 Accounts
Historically, there has been a major issue when grandparents begin distributing money out of these 529 accounts to pay college expenses for their grandchildren which can hurt their financial aid eligibility. While these accounts are invisible to the FAFSA calculation as an asset, in the year that the distribution takes place from a grandparent owned 529 account, those distributions now count as “income of the student” in the year that the distribution takes place. Income of the student counts heavily against the need-based financial aid award. Currently, any income of the student above the $7,040 threshold counts 50% against the financial aid award.
For example, if a grandparent distributes $30,000 from the 529 account to pay college expenses for the grandchild, in that determination year, assuming the child has no other income, that distribution could reduce the financial aid award two years later by $11,480.
FAFSA Two-Year Lookback
FAFSA has a two-year lookback for purposes of determining income in the EFC calculation (expected family contribution), so the family doesn’t realize the misstep until two years later. For example, if the distribution takes place in the fall of the student’s freshman year, the financial aid package would not be reduced until the fall of their junior year.
Since we are aware of this income two-year lookback rule, the workaround has been to advise grandparents not to distribute money from the 529 accounts until the spring of their sophomore year. If the child graduates in four years by the time they are submitting the FAFSA application for their senior year, that determination year that 529 distribution took place is no longer in play.
Quick Note: All of this only matters if the student qualifies for need-based financial aid. If the student, through their parent’s FAFSA application, does not qualify for any need-based financial aid, then the impact of these distributions from the grandparent owned 529 accounts is irrelevant because they were not receiving any financial aid anyways.
New Rules Starting in 2023
But the rules are changing starting in 2023 to make these grandparent owned 529 accounts even more advantageous. Under the new rules, distribution from grandparent owned 529 account will no longer count as income of the student. These 529 accounts owned by the grandparents are now completely invisible to the FAFSA calculation for both assets and income, which makes them even more valuable.
Tax Deduction For 529 Contributions
There can also be tax benefits for grandparents contributing to 529 accounts for their grandkids. Certain states allow state income tax deductions for contributions up to a certain thresholds. In New York State, there is a $5,000 state tax deduction for single filers and a $10,000 deduction for joint filers each tax year. The amounts vary from state to state and some states have no deduction, so you have to do your homework.
What If The Grandchild Does Not Go To College?
What happens if you fund this 529 account for your grandchild but then they decide not to go to college? There are a few options here. The grandparent can change the beneficiary of the account to another grandchild or family member. The second option, you can just take a distribution of the account balance. If the balance is distributed but it’s not used for college expenses, the contribution amounts are returned tax and penalty-free but the earnings portion of the account is subject to ordinary income taxes and a 10% penalty since it wasn’t used for qualified college expenses.
K - 12 Qualified Expenses
The federal government made changes to the tax rules in 2017 which also allow up to $10,000 per year to be distributed from 529 accounts for K - 12 expenses. If you have grandchildren that are attending a private k -12 school, this is another way for grandparents to potentially capture a tax deduction, and help pay those expenses.
However, and this is very important, while the federal government recognizes the K – 12 $10,000 per year as a qualified distribution, the states which sponsor these 529 plans may not adhere to those same rules. In fact, in New York State, not only does New York not recognize K – 12 expenses as “qualified expenses” for purposes of distributions from a 529 account, but these nonqualified withdrawals also require a recapture of any New York State tax benefits that have accrued on the contributions. Double ouch!! These rules vary state by state so you have to do your homework before paying K – 12 expenses out of a 529 account.
About Michael……...
Hi, I’m Michael Ruger. I’m the managing partner of Greenbush Financial Group and the creator of the nationally recognized Money Smart Board blog . I created the blog because there are a lot of events in life that require important financial decisions. The goal is to help our readers avoid big financial missteps, discover financial solutions that they were not aware of, and to optimize their financial future.
Potential investors of 529 plans may get more favorable tax benefits from 529 plans sponsored by their own state. Consult your tax professional for how 529 tax treatments and account fees would apply to your particular situation. To determine which college saving option is right for you, please consult your tax and accounting advisors. Neither APFS nor its affiliates or financial professionals provide tax, legal or accounting advice. Please carefully consider investment objectives, risks, charges, and expenses before investing. For this and other information about municipal fund securities, please obtain an offering statement and read it carefully before you invest. Investments in 529 college savings plans are neither FDIC insured nor guaranteed and may lose value.
