Back to school, back to savings: 529 plans as a strategy
The delightful days of summer — when kids go to bed late and sleep in, worrying only about what video game to play or whether they’re putting on enough sunscreen in the pool — are coming to an end as students across the country go back to school. As our clients begin to tick off items on their back-to-school shopping list and adjust to the change in routine, now is the perfect time to advise them on saving for education to improve life. future of their family.
In addition to education-related tax credits and state sales tax exemptions for back-to-school expenses, Section 529 college savings plans can be a great tool to position a family to succeed.
Rising tuition fees and the need to save early
Like food, housing, and almost every other expense, tuition is on the rise. In 2022, the average annual tuition for an in-state post-secondary school is over $11,000, over $28,000 for out-of-state tuition, and over $43,000 for out-of-state tuition. tuition at a private university. This does not include books or room and board. Additionally, more and more students need higher-level degrees and certifications to land the jobs they want.
Simply put, education is often one of the most important investments parents will make for their children. Saving today can soften the financial blow.
529 education investment plans
Section 529 plans are college savings plans that can be used for the account beneficiary’s higher education expenses. Account holders enjoy tax benefits, flexibility and control.
When customers open a 529 account, they must select a beneficiary for whom all funds will be used to cover their eligible education expenses. The IRS also refers to the plans as Qualified Tuition Programs, or QTPs. Clients can open a 529 plan for themselves or for any beneficiary.
Think of a 529 plan as an investment tool similar to a 401(k) plan. Clients invest money in a variety of ways: stocks, bonds, mutual funds, etc. 529 plans are typically invested with age-based funds, which means asset allocation typically shifts from an aggressive to a more conservative strategy as the student gets closer to college. Funds grow tax-free until a client needs them to pay for education. Distributions are then tax-free, assuming they are used to pay eligible educational expenses.
And while there is no federal deduction for contributions to a 529 plan, there are some state tax benefits to reduce taxes. Many states offer a 529 tax benefit in the form of a deduction or credit, allowing customers to reduce their income tax burden.
Eligible education expenses
529 funds must be used for eligible educational expenses so that all withdrawals are tax-free. Here are some examples of eligible education expenses:
- Tuition and Fees
- Necessary books and school supplies
- Room and board (with certain stipulations)
- Computers and related equipment such as printers
Expenditure for primary and secondary education
Additionally, up to $10,000 per beneficiary per year can be withdrawn to cover private or religious K-12 schools, through the Tax Cuts and Jobs Act, signed into law in December. 2017. Practitioners should check state rules before advising clients to ensure state follows expansion.
It might be helpful to advise clients to track funds separately for college and K-12 expenses, as education needs fall into different timelines. Matching investment strategies to meet schedule requirements is crucial to overall education spending strategy and is an area that practitioners will rely on for guidance.
Affluent families can benefit from “super financing” of their 529 plans. High net worth clients (parents or grandparents) can take advantage of a five-year gift tax averaging strategy that allows them to collect their contributions without having to pay gift tax, while retaining their lifetime exemption from gift and inheritance tax.
This means that a client could contribute five times the annual gift tax exclusion as an initial contribution. The annual exclusion is $16,000 in 2022 ($32,000 for married couples). Therefore, a client could take out $80,000 ($160,000 for married couples) to “superfund” a 529 plan. This is a great way to get more money into the 529 plan quickly so it can grow. longer and keep the money out of the estate.
Practical tips and considerations
CPAs and advisors should encourage clients who are parents to consider opening a 529 plan when their children are very young to take advantage of the greatest potential for tax-free growth. I opened my children’s accounts when they were babies. The longer the money can grow, the more money there will be for our children later.
CPAs should also inform their clients that, if financially feasible, superfunding a 529 plan may also make sense for parents who decide to send their children to private K-12 schools. Often parents of young children have not had much time for contributions to increase. However, if the parents (or grandparents) collected the contributions, they could produce better financial results. Transferring money to investment accounts that grow tax-free can ease some of the tuition burden.
Keep in mind that even though a customer needs to select a beneficiary, they can still change that beneficiary if they need to. For example, if a customer has two children and one child chooses not to go to college, the customer could transfer the funds to the child who goes to college.
And we all know that life’s challenges arise and clients sometimes need to dip into emergency funds. Contributions to a 529 plan are made with after-tax money, meaning account holders can withdraw any portion of their original contributions without taxes or penalties (a 10% penalty only applies to earnings on the account).
See IRS Publication 970, Tax Benefits for Education, for additional guidance on college credits, savings plans, and more. The AICPA Tax Section’s Odyssey podcast series also offers information on a variety of tax and planning topics.
Enjoy the last days of summer
Soon, school buses will be part of everyone’s morning commute, and nights will be filled with homework and earlier bedtimes. Enjoy the end of summer while keeping an eye on your clients’ long-term financial plans.
This article does not necessarily reflect the views of the Bureau of National Affairs, Inc., publisher of Bloomberg Law and Bloomberg Tax, or its owners.
Susan Allen, CPA/CITP, CGMA, is a senior member of the Tax Practice and Ethics team at the American Institute of Certified Public Accountants. She leads the content strategy to ensure members receive the advice and support they need to remain leading tax service providers.
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