A 529 Plan Can Help Cover the Growing Costs of a Child or Grandchild’s Education

A 529 or “qualified tuition” plan is federally authorized savings plan that you can use for a child's or grandchild's college tuition and other educational expenses. In most states, contributions to the plan are tax deductible (state), and the earnings in a 529 account are not subject to federal income tax.

Here are the features of AZ529: Arizona’s Education Savings Plan:

• offers parents, grandparents, and students an opportunity to save for “qualified education” expenses – tuition, books, and room and board – in a tax-deferred manner;
• can be used to pay for college, vocational and workforce training, apprenticeships, and private K-12 education;
• grows tax-free; withdrawals are taxed only if used for purposes outside the scope of the plan;
• offers an Arizona income tax deduction for contributions of up to $4,000 for married couples filing jointly and up to $2,000 for individuals; and
• can feature a variety of investment options, from FDIC-insured CDs to mutual funds.

You are not restricted to your state’s plan. If the plan of another state is a better fit for your situation, you are free to select it.

529 IMPROVEMENTS

In its original form, dating back to 1996, a 529 plan could be used only for college or other post-secondary-school costs.

Private K-12 Tuition. That continued to be the case until 2017, when the Tax Cuts and Jobs Act significantly expanded the scope of "qualified education expenses," allowing the withdrawal, in Arizona and most other states, of up to $10,000 per year, per beneficiary, for private K-12 tuition. (Other private K-12 education-related costs, such as books and computers, must be purchased with non-529 funds. Also, costs of homeschooling are not eligible for 529 plan proceeds.)

Student Loan Repayment. In the 2020 SECURE Act, the federal government recognized student loan repayment as a qualifying education expense. You can use up to $10,000 per beneficiary to repay student loans. A 2023 Forbes article describes various limitations and other details.

Roth IRA Rollovers. Starting this year, with implementation of the SECURE 2.0 Act, 529 account owners gained additional flexibility: If your 529 account has unused funds, you can roll them over to a Roth IRA.

This flexibility has a few limitations:

• The Roth IRA must be owned by the beneficiary of the 529 account – i.e., the child or grandchild for whom the education saving was intended.
• The 529 must have been open for more than 15 years before it can be rolled over to a Roth IRA.
• The total amount of the rollover is limited to $35,000.
• The Roth IRA rollovers are subject to the same annual contribution limits that apply to direct contributions – e.g., $7,000 per person for 2024 – minus any contributions that the beneficiary makes directly.
• Rollover amounts are also affected by the beneficiary’s earned income: The amount of the rollover cannot exceed the beneficiary’s earned income for that year.

Special Needs Education. For children with a disability, the federal ABLE Act allows 529 plans to be re-purposed and rolled over to a state-specific ABLE account, which is a type of savings account for people with special needs. Money in an ABLE account can be used to pay for certain types of “qualified expenses,” e.g., education, housing, transportation, job training and support, assistive technology, health and wellness, financial management, and legal fees.

Before initiating a rollover from a 529 plan to an ABLE account, you should consider the potential benefits and risks, including these:

• Funds in an ABLE account generally do not affect a beneficiary’s eligibility for Medicaid or other federal benefits (although accounts with more than $100,000 may affect a person’s eligibility for SSI).
• Money saved in 529 plans is protected from Medicaid payback (i.e., the government is barred from seeking repayment of Medicaid costs from a 529 plan that benefits a person with special needs who passes away.) In contrast, in such situations, the government can seek payback from an ABLE account.
• The ABLE rollover amount counts toward the account’s yearly contribution limit ($18,000 in 2024). Before making a rollover, you will want to confirm that it will not cause the account to exceed its limit for the year.

You can read about Arizona’s program, “AZ ABLE,” at az-able.com.

ESTATE TAX PLANNING

As we have discussed in previous articles, if Congress does not act, after 2025 the estate tax exemption will drop from $13.6 million per person to just $6.2 million (i.e., $5 million adjusted for inflation). As a consequence, your seemingly modest estate, which up to this point has not warranted estate tax planning, could become subject to taxation after your death.

If that scenario could apply to your estate, owning a 529 account can be a useful tool, as the money it contains is exempt from federal estate tax.

Also, a 529 plan contribution is treated as a gift to the beneficiary. Because contributions of $18,000 or less in any year are excluded from gift tax, you can use your yearly contributions to max out the gift tax exclusion.

You can front-load a 529 by making a lump-sum contribution of up to $90,000 – $18,000 per year (2024 limit) for five years – without incurring a gift tax. If you are able to seize that opportunity, the value of the account after five years will likely be greater than if you space your contributions over five years.

The estate tax benefits of a 529 are not limited to the account owner. Because 529 plans are eligible for third-party contributions, you can contribute to a 529 plan that your adult child set up for your grandchild.

PLANNING CONSIDERATIONS

You can set up a 529 plan through your investment advisor; using an attorney, at least on the front end, should not be necessary. As a “qualified” account, a 529 is subject to the same transfer limitations as an IRA and cannot be moved into a trust.

Nonetheless, 529 plan ownership should be factored into your overall planning and periodic estate plan reviews, so that, when you pass away, the plan can be easily transferred outside of probate. You should designate a back-up owner to administer the account in case you die prematurely, and you should name a back-up beneficiary in case the primary beneficiary dies before the account is exhausted.

For parents and grandparents, a 529 plan offers significant benefits, without any apparent drawbacks. To explore your plan options and strategies, contact your investment advisor.