You save and invest your money to prepare for many life events: retirement, buying a house, and college expenses, to name a few. Each event takes place at different stages of your life, which means the time you have to save and prepare for each one varies. The closer you are to those events, the more prudent it is to take less risk with your investments because you have less time to recover from a market correction.
With the recent market volatility, many people are finding that the investment allocation of their 529 accounts is weighted towards high-growth assets — exposing them to more market risk than what they realized. With 529 college savings accounts, there is a pretty clear target of when those dollars are needed, and it’s important to make sure the asset allocation accurately reflects how much time before a child goes off to college. If it doesn’t, the money saved in a 529 plan may not go as far as it needs to.
We work with clients to ensure their investments are properly aligned with their goals and their timeframes. We build portfolios with exposure to stocks and bonds for optimal growth, and as a child gets closer to college, we adjust the allocation away from stocks and towards bonds, which historically have provided a lower level of risk.
May 29th, or 5/29, is National 529 College Savings Plan Day: a day to raise awareness about the importance of saving for college. In honor of 529 Day, we thought we’d take the opportunity to answer the college savings questions we get asked most often by our clients. Additionally, due to COVID-19, many of our clients have been managing tuition refunds in recent weeks. If the funds came from a 529 plan, the tuition refund may trigger a “taxable event.” If you need help navigating tuition refunds, please skip ahead to FAQ #7 or connect with our team.
1. How does the account work?
A 529 account has an owner and a beneficiary. The beneficiary is always the student, and the owner is typically either the parent or a relative of the student.
It’s important to note that the beneficiary does not have access to the account—the owner controls the account and makes all investment and withdrawal decisions. Only one beneficiary and one owner is allowed on the account, and a successor owner is named on the account in the event the current account owner becomes incapacitated or dies.
2. Who can open and contribute to a 529 plan?
To open an account, you must be a resident of the United States, at least 18 years old, hold a valid social security number, and a valid address. Anyone can contribute to an existing 529 plan, however.
3. Are there age or income restrictions to contribute to 529 plans?
No. There are no age or income restrictions to contribute to 529 plans.
4. How much can I contribute to a 529 plan?
In 2020, a single person can contribute up to $15,000 and a married couple can contribute up to $30,000 before gift tax considerations need to be taken into account. Anything over that amount must be reported to the IRS as a gift on form 709.
529 plans also have a special feature that allows lump-sum contributions of up to five times the annual limit. In this case, an individual can contribute $75,000 and a married couple can contribute $150,000, provided you make a special election on your federal gift tax return. This spreads the lump-sum gift over five years; it’s important to note, however, that you are restricted from making any other gifts to the account over the next five years. Further gifts to the beneficiary during the five-year period will have gift tax consequences. The lump-sum contribution is most commonly used when there is a need to move money out of an estate, and it can help supercharge the 529 account in the process.
5. What expenses are covered by a 529 plan?
A 529 plan can be used for most higher education expenses, including tuition, fees, books, and supplies. Room and board is also covered, so long as the student is enrolled at least half-time.
6. What happens if there is money left over in a 529 account?
Any remaining money still belongs to the owner of the account. The account owner has three options:
a. Update the beneficiary to another family member (siblings, parents, nieces, nephews, aunts, uncles, and first cousins). There is no income tax consequence in this scenario, but such transfers may be considered a gift.
b. Use the money for non-educational purposes. In this case, the owner of the account will pay a 10% penalty and ordinary income tax on any earnings, but not the principal since 529 plans are funded with after-tax contributions.
c. The funds can be left in the account for the current beneficiary in case they intend to return to school at a later date, or until the account owner selects a new beneficiary.
7. What if I received a tuition refund due to the COVID-19 pandemic?
If you’ve received a refund for tuition that was paid for from a 529 plan, it’s important that you manage the funds properly. If you don’t, it may create a “taxable event” where the refunded amount is considered a non-qualifying distribution and the funds can be taxed as outlined in point #6b above. Additionally, you may also be required to pay back any state tax deductions you previously claimed.
To avoid triggering a taxable event, you have two options for refunded tuition payments:
1. Apply the funds to a qualified educational expense in 2020, or
2. Recontribute the funds to the 529 plan within 60 days of receiving the refund
As always, it’s important to document the refunded tuition. If you need any help or guidance while managing refunds, please don’t hesitate to reach out.
8. Do I have to invest in my own state’s plan?
No, but there may be tax benefits that encourage you to invest in your own state’s plan. Regardless of which state plan you choose, the funds can be used at any accredited university, vocational school, or post-secondary educational institution that’s eligible to participate in a student aid program administered by the U.S. Department of Education. So, for example, an Illinois resident can invest in an Illinois 529 plan and attend a school outside of the state.
9. Do Illinois and Wisconsin offer any tax benefits to invest in their 529 plans?
Yes, they do. An individual Illinois resident can deduct up to $10,000 in contributions to an Illinois 529 plan per year from their state income tax. Married couples filing taxes jointly can deduct up to $20,000 per year, regardless of the number of children they have. For example, if a couple contributed $20,000 per year to their child’s 529 plan, they would get a state tax benefit of $990 ($20,000 x 4.95%, the Illinois state tax rate).
Wisconsin residents can deduct up to $3,340 of contributions to a Wisconsin 529 plan per beneficiary per year, regardless of filing status. Excess amounts are eligible to be carried forward to future years. The amount of the benefit each year will depend on the contributor’s tax rate and the number of plans funded.
10. When do I have to make the contribution?
Assuming the account is already open, contributions to Illinois 529 plans must be postmarked on or before December 31st of the given calendar year. Wisconsin allows for calendar year contributions to be made until that year’s tax filing deadline. Other states’ 529 plans may have different deadlines, so be sure to confirm before mailing a check.
11. Can I invest in whatever I want?
No, each state has a list of funds for investment.
12. How often can I change the investments?
Twice in a rolling 12-month period.
13. I heard the federal government now allows K-12 expenses to be paid from a 529 plan. Is this true?
The federal government and Wisconsin do permit K-12 expenses to be paid from a 529 plan, though Illinois does not.
14. What happens if the beneficiary gets a scholarship?
In the case of a scholarship, non-qualified withdrawals up to the amount of the tax-free scholarship can be taken out without the standard 10% penalty, but you will have to pay income tax on any earnings.
15. How do I withdraw money from a 529 plan?
First, be sure to match the payments of the qualifying expenses to the correct tax year, not the school year. There are a few options available for withdrawing money:
1. The school can be paid directly from the 529 account.
2. Money can be moved from the 529 account to your bank account. Expenses can then be paid from your bank account.
3. Expenses can be paid from your bank account first, then reimbursed from the 529 account later. This option may be easiest for expenses like books or a computer.
Regardless of the method of payment and withdrawal, be sure to keep meticulous records when moving money from a 529 account. It is your responsibility to report all educational expenses to the IRS.
If this didn’t address one of your questions or you would like more information about 529 plans, please do not hesitate to reach out to us and we’ll be happy to assist you.