Frequently asked 529 questions
529 college savings plans allow you to offer an expanded lineup of services to help meet your clients' needs in three ways:
- Expand client relationships.
- 529s are a great entryway into estate planning and generational wealth transfer conversations.
- 529s allow accelerated gifting from a lump sum gift of $15,000 to $75,000 and have it treated as if it were given over five years with no gift tax consequences.
- Deepen family connections:
- If your clients have grown children, talk to them about funding a 529 for their grandchildren and start a conversation about which other relatives may want to contribute to the child's 529 plan.
- By starting the 529 conversation, you've set yourself up to ask for referrals.
- Grow relationships with business owner clients:
- With benefits costs on the rise, a 529 plan is a great low-cost and paperless benefit the company can offer to its employees.
- Also, clients who are employees at firms that don't offer a 529 benefit are ideally suited to introduce you to their HR department, where you may find opportunities to serve as the advisor for a new 529 employee benefit.
That's a problem most of us wish we had… a 529 college savings plan with too much money in it. But the student may receive a scholarship or decide against something they originally planned on. Then your client basically has five options:
- Keep the account as is for potential future educational needs of the beneficiary.
- A 529 plan is flexible - it can be used to pay qualified educational expenses at any eligible post-secondary institution.
- Transfer the account to a different beneficiary.
- The account holder can name another qualifying family member, including herself, as a beneficiary without triggering tax consequences.
- Younger siblings, nieces and nephews all qualify.
- Leave an education legacy.
- Because most 529 plans don't impose a time limit for using the money, your client and his successors can let the account continue to grow, potentially for grandchildren and even great-grandchildren.
- Take penalty-free withdrawals.
- If the beneficiary earns a scholarship or appointment to a US military academy, the owner can withdraw up to the amount of the scholarship.
- While there's no penalty, earnings in the account are taxable.
- Spend the money on non-qualified expenses.
- The after-tax contributions your client made to the 529 can be withdrawn without tax or penalty.
- Only the earnings on the contributions will be taxed as income, and are subject to a 10% penalty.
This is an important question to consider as you help parents incorporate paying for college into their overall financial plan.
There are three drawbacks with funding a single 529 for two or more children:
- 529 plans can be used only for qualified higher-education expenses of the named beneficiary, and only one beneficiary at a time.
- Investment allocation in age-based 529 portfolios are based on the age of the beneficiary, moving from aggressive to more conservative as college gets closer.
- Your client may not be able to take full advantage of tax breaks that 529 accounts offer, including individual gift tax exclusions.
One account for two children may make sense if, for example, there's a significant age difference. The owner could change the beneficiary when the older child has completed college and, of course, tweak the 529 investment allocation for the younger child.
Now, let's consider the strategy of opening a 529 account for each child. It remedies the drawbacks of having only one account for multiple kids because:
- All funds for qualified expenses are distributed tax-free for each beneficiary
- The most appropriate time-based investment allocation can be chosen for each child
- Your clients could potentially minimize tax breaks
- It's easier to track progress for each child
529 rollovers are an exception rather than routine, but you should consider five scenarios:
- There's a more appropriate option. If there's a new investment manager that offers investing options and underlying investments with greater potential to help your client meet his goals, it may be wise to consider a change.
- Your client's plan suffers chronic underperformance. If you anticipate your client's current 529 will continue to underperform versus benchmarks or competing plans, you may want to consider a change.
- There's a better value for the money. You may want to consider a lower cost plan, as long as it offers the features, service levels and performance that make the switch worth it.
- Your client can get a home-team advantage. It's worth checking out if your client may benefit from a home-state 529, depending on whether the state allows the deduction for rollover contributions.
- The plan has restrictions that interfere with your client's goals. For example, a grandparent sets up an account for a grandchild beneficiary and then later decides to turn ownership of the account over to his son, the father of the beneficiary. If the 529 doesn't allow for voluntary ownership change, rolling over to a 529 that does allow owner changes may meet the grandparent's needs better.
There's one more important factor to consider: Before suggesting a 529 plan change, check whether a rollover may trigger processing fees or state tax recapture fees, which vary by state, and be sure you understand any tax implications.
Every year, students who seek federal, need-based financial aid must fill out the Free Application for Federal Student Aid (FAFSA). It asks parents and students to disclose two things:
- Assets include such things as:
- Money saved in cash, savings and checkings accounts.
- Businesses and investment properties.
- Other investments, such as UGMA and UTMA accounts, stocks, bonds, CDs, etc.
- Income is basically the same information your client reports on their income tax return.
All that information is plugged into a formula that calculates what the government calls the Expected Family Contribution (EFC), which tells colleges how much money the family has that can be used to contribute to college expenses.
- The EFC formula doesn't treat all assets and income the same. For example, it includes up to 20% of a student's assets and 50% of a student's income. For parents, the EFC calculation counts only 5.64% of assets but up to 47% of income.
- For grandparents and anyone else who gives money toward the student's college expenses, nothing is counted as assets. But, once the student spends that money on qualified expenses, the EFC calculation will count half of that as income for the year in which it's spent. That means the following year, when the students fills out the FAFSA, they’ll have to report that money as income.
|Dependent student||Custodial parent||Grandparents/others|
|Assets||Student-owned accounts are counted as parental assets on the FAFSA.||Parent-owned accounts are counted as parental assets on the FAFSA.||Grandparent-owned accounts are not included in FAFSA asset calculations.|
|Income||Qualified distributions are not counted as income.||Qualified distributions are not counted as income.||Distributions from a grandparent's plan are counted as "untaxed student income."|
If your client has the means to consider a “living legacy” to her grandson, I can think of at least three reasons she may find a 529 college savings plan a good option.
- Control. As the 529 account owner, your client controls the assets. Not the grandchild. This helps to ensure that the savings are used for educational purposes.
- Flexibility – in this case the grandson would get a choice of schools. In addition to the traditional public and private four-year universities, there’s a huge selection of eligible post-secondary institutions the beneficiary can choose from, including trade and vocational schools, community colleges, graduate programs, foreign institutions and online programs.
Also flexibility in the sense that the grandmother has control over any remaining funds. If there are funds left in the 529 after the beneficiary graduates, or if the beneficiary doesn’t use them, the owner can designate another beneficiary without tax consequences.
- Taxes. 529 plans offer several potential tax breaks. And you can check these in detail at CollegeBound529.com.
For most of us, grandparents are the human link to our past and our heritage. With 529 college savings plans, grandparents have an opportunity to become an important link to their grandchildren’s future while benefiting from the financial incentives 529s offer.
Unlike saving for retirement, college savers have a much shorter time frame – usually 18 years at the most. And they have a much shorter time frame for using the money – usually within four years. That calls for a Goldilocks investment approach – not too aggressive, not too conservative.
- Stocks may provide growth potential, which is important when children are young and college is years away.
- Bonds may provide lower risks, which is important when children are older and distributions are coming sooner rather than later.
Choosing an initial allocation and adjusting it as the years go by is a critical task. Many parents choose age-based portfolios that have a built-in glide path that adjusts the allocation over time. But not all age-based portfolios are built alike so consider plans that design the portfolio with the unique needs of college savers in mind.
Many people think that the goal is too big to achieve. Many people see the "sticker price" of college and do nothing because the amount looks unachievable. But here's a reality check: Parents don't need to save the full sticker price. As I've always said: "If you put away a little bit of money for a long time, you'll have a lot more money saved than if you didn't." So the most important step is the first step – getting started.
529 savings can be used for a variety of education-related expenses at eligible (accredited) two- and four-year colleges and universities, US vocational-technical schools, and eligible foreign institutions, including:
- supplies and equipment
- other expenses: For more details, visit IRS Publication 970, Tax Benefits for Education.
Talk to your clients about the potential for them to either fund a 529 for themselves or to deliberately overfund their child or grandchild's account, then ultimately transfer the account to themselves after the child graduates.
Why? Retirees often want to take courses in subjects they plan to pursue in retirement. Many accredited universities are now offering such classes specifically to accommodate them — including classes in foreign countries.
None of the State of Rhode Island, its agencies, Invesco Distributors, Inc., Ascensus College Savings Recordkeeping Services, LLC, nor any of their applicable affiliates provide legal or tax advice. This information is provided for general educational purposes only and is not to be considered legal or tax advice. Investors should consult with their legal or tax advisors for personalized assistance, including information regarding any specific state law requirements.