Is a 529 Educational Savings Plan Right for You?
Answers to Commonly Asked Questions
By Alyssa Leach, CPA, Director
529 Plans were created over 25 years ago and their purpose and benefits have stood the test of time, continuing to help families ease the burden of paying for rising educational costs.
If you’re not familiar with 529 Plans or are still debating at the kitchen table if contributing to one makes sense for your family, please read on as we provide answers to common questions about 529 Plans, including the range of educational expenses they can be used for and their tax benefits.
A 529 Plan Explained
A 529 Plan is a state-sponsored tax advantaged investment account designed specifically for education expenses. They were established under Section 529 of the Internal Revenue Code. The money in the plan is invested on behalf of a child or designated beneficiary for which the funds are allowed to be used. Contributions can be made over a beneficiary’s lifetime and, provided withdrawals are used for qualified education costs, all distributions and earnings are tax free.
Can anyone contribute?
While anyone can contribute to a 529 Plan for a child, they are most often established and funded by parents and grandparents for children at a very young age, with contributions being made directly to the 529 Plan.
Is a contribution to a 529 Plan considered a gift, where filing a gift-tax return is required?
Filing a gift-tax return is not required if the amount of the contribution is below the annual gifting limit ($18,000 for 2024). In addition, under the five-year rule, an individual can contribute up to the gift-tax limit for five years ($90,000 in 2024) and treat the contribution as if it were made over the five-year period ($18,000 per year).
Unless you make other gifts above the exemption, there would be no requirement to file a gift-tax return based solely on the 529 Plan contributions.
What are considered qualified education expenses?
The plan beneficiary must be enrolled in an eligible higher educational institution — defined broadly as colleges, trade and vocational schools, post-graduation programs and certain apprenticeship programs. Below is a list of expenses that would qualify the 529 distribution for tax-exempt status.
- Tuition, including fees
- Books and supplies which allow for the purchase of a computer and related equipment (provided they are used while the beneficiary is enrolled).
- Room and board.
NOTE: If you didn’t already know, the Tax Cuts and Jobs Act of 2017 has added the ability for $10,000 per year to be used for private elementary or secondary school tuition expenses — adding another level of tax relief for families in addition to 529 Plans.
Are 529 Plan contributions tax deductible?
While there is no federal tax deduction available for 529 Plan contributions, account owners will benefit from tax-free growth over the years. There are also certain states that offer varying levels of tax deductions, dependent on the amount contributed. These states include Connecticut, Maryland, Massachusetts, New Jersey, New York and Rhode Island.
What happens if the beneficiary doesn’t use the funds for qualified educational expenses?
If the beneficiary doesn’t use the funds for qualified expenses or ends up not needing a portion of the funds you’ve contributed to the 529 Plan, there are a few options available for the balance.
- A distribution can be made for any tax-free scholarship amounts received by the beneficiary.
- Only the earnings from the distribution would be subject to tax.
- Any applicable penalties would otherwise be waived.
- Ownership of one 529 Plan can be transferred to another beneficiary without any tax implications, provided the state allows it.
- If the above two options aren’t available, the remaining funds can be withdrawn and a 10% penalty would be incurred on the earnings portion of the distribution.
Bottom Line: What do we think of 529 Plans?
We think 529 Plans are an excellent option to ease the daunting financial burden of rising education costs. With tax-free status on earnings and distributions for qualified educational expenses, 529 Plans can offer much needed relief for many families.
Contact Us
We’re here to help you think through establishing a 529 Plan. If you have any questions, contact your PKF O’Connor Davies client service team or feel free to connect with me directly:
Alyssa Leach, CPA
Director
aleach@pkfod.com