September 13, 2019
Saving for the Future: The Basics of 529 Accounts
by Todd Walter, The Joseph Group
Growing up, my Dad always told me to “use the right tool for the right job.” Sage advice. When it comes to education savings, there are several tools in the toolbelt, but the 529 account is still the most popular choice.
Tax-free growth and tax-free distributions when used for qualified education expenses – that’s the primary benefit of 529 plans. Qualified expenses include:
• Tuition and fees
• Books, supplies and equipment required for enrollment
• Room and board if enrolled in an eligible college program on at least a half-time basis
529 accounts have traditionally been used for college, graduate and trade schools, but starting in 2018, 529s can be used to pay for up to $10,000 per year of tuition at elementary or secondary schools. Any 529 distributions not used for qualified expenses are subject to ordinary income tax and a 10 percent penalty on the earnings portion (principal distributions are tax free). Unused 529 dollars are not required to be distributed and can be transferred to related beneficiaries and/or used for future generations.
Almost every state has a 529 plan. In Ohio, we are blessed to have one of the best 529 plans in the country, as Ohio’s College Advantage consistently receives high overall and performance ratings. Contributions to Ohio’s 529 plan by Ohio income tax payers receive an Ohio income tax deduction of up to $4,000 per beneficiary per year. When setting up a 529 for a beneficiary in another state, consider that state’s income tax benefits.
Much of college tax planning is focused on the Federal tax credits: the Lifetime Learning Credit and the American Opportunity Tax Credit. 529 dollars cannot be the same dollars used to claim those tax credits. With the American Opportunity Tax Credit (AOTC), eligible expenses include the first $4,000 of expenses paid each year for the first four years of higher education. So, for example, if actual college costs are $20,000, and $4,000 is to be used for the AOTC, 529 distributions cannot be more than $16,000 for that year.
Investment choices within a 529 will vary from state to state, with the owner selecting the appropriate choice, but a unique option in most 529 plans is the “age-based” investment option. Age-based investments are more aggressive when the child is very young and slowly get more conservative as the child gets closer to college. This intentional glidepath helps mitigate the risk of losing value when resources are finally needed for expenses.
We often see grandparents establishing 529 accounts for their grandchildren. This is an excellent planning opportunity as 529 accounts owned by someone other than the parent or the child are excluded as assets from the financial aid equation. 529 accounts can leave a great legacy for future generations.
So, Dad, if this is the right tool, would you like to contribute to your grandchildren’s 529 accounts?