College football and back to school season are upon us, so that means many families will soon have the daunting task of paying for an upcoming year of college. Thankfully, the Internal Revenue Code provides options that can alleviate some of that stress through the use of qualified tuition programs, also known as 529 plans.
Qualified higher education expenses include tuition (including up to $10,000 in tuition for an elementary or secondary public, private or religious school), fees, books, supplies and required equipment. Reasonable room and board are also a qualified expense if the student is enrolled at least half the school year.
There are two types of 529 plans available:
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- Prepaid Plans. This allows an individual to pay for a beneficiary’s (yourself or another designated individual) at present rates even though the beneficiary will not be attending college for some time.
- Savings Plans. This allows you to invest your college savings in several types of mutual funds, bond funds, and exchange-traded fund portfolios. These savings plans operate like a 401k or IRA retirement plan in which your account could go up or down depending on market performance.
For those wondering how this may affect their 1040, there is no federal tax deduction on an individual return for making contributions to a 529 plan, but there may be state benefits. Check out your state’s treasury FAQ to determine if that may be the case. A major advantage of adding money to a 529 plan is that the income from the investments is not taxed annually, and will not be taxed at all when used for qualified education costs.
For most individuals, a tax event will occur only when there is money taken from the account, known as a distribution. The owner of the account will receive a 1099Q for their tax records. As long as the entire distribution was to pay for qualified educational expenses there will be no tax. If there are distributions in excess of the qualified expenses then there will be an amount of the distribution that is taxable based on an allocation of the earnings from the plan, with a possible 10% penalty depending on the situation. 529 plan distributions do work in conjunction with education credits, so please speak to a tax professional to ensure you are completing forms appropriately.
Contributions to the 529 are considered a gift and may be subject to a gift tax, but most individuals will meet the criteria for the gift tax exclusion. As of January 1, 2024, the federal annual gift tax exclusion increased from $17,000 in 2023 to $18,000 for a single individual and from $34,000 to $36,000 for married couples filing jointly. The exclusion operates on a per beneficiary basis, not based upon your total amount of gifts in the year (i.e., you can give two individuals $18,000 and both gifts meet the exclusion).
An individual can also consider superfunding. This strategy elects to make a lump sum payment for five years’ worth of 529 contributions in one year. That means you can contribute up to $90,000 to a 529 plan ($180,000 if married, giving jointly) in a single year and not owe any gift taxes. Any additional contributions during the next four years to that beneficiary would be subject to gift tax, except to the extent that the exclusion amount increases.
It might make sense to roll one 529 plan to a different plan if the owner wants to move the money to a different family member under a different plan or if the owner identifies a plan with superior investment options. A rollover from one 529 plan to another 529 plan does not trigger income tax as long as it is for the same beneficiary or for the benefit of a member of the beneficiary’s family. A rollover is allowed once every 12-month period. A distribution from a qualified tuition program is not subject to gift tax, but a change in beneficiary or rollover to the account of a new beneficiary may be.
Please contact AHP if you have any questions about education saving opportunities!
