529 Plans Explained
A 529 is a tax-advantaged investment account which encourages individuals to save for future higher educational expenses. Named for Section 529 of the Internal Revenue Code, the investment account offers tax-free withdrawals and earnings growth when the funds are used to pay for qualified education costs. You are not limited to investing in the state where you reside—Any U.S. state’s 529 plan can be used to pay for future college expenses at any qualified college in the United States. According to the Wall Street Journal’s The 6 Biggest Questions About ‘529’ Plans, American families have invested approximately $329 billion in 529 plans, with about $24,153 existing in each account.
Money deposited into a 529 investment account is considered a gift to the recipient—meaning, that this money grows tax-free until it is withdrawn to be used for qualified educational expenses such as tuition. These withdrawals do not incur any federal or state taxes. Additional benefits include pre-funding accounts and allowing anyone, in addition to the account owner, to contribute to this education savings plan. Non-qualified withdrawals—taking the money out without using it for qualified educational purposes—will be subject to a 10 percent federal penalty on the gains portion of any withdrawals, including state and federal income tax on gains.
Most valuable, is that there are no time limits on 529 plans. The money placed into your 529 account can earn tax-free returns indefinitely. The beneficiary may receive the money in the 529 account at any time. Should they decide to attend graduate school, the money may pay for that education. Additionally, the money may remain in the account for future grandchildren, or the named beneficiary may be changed to any of the original beneficiary’s direct family members.
529 Savings Impact Financial Aid Packages
Parents should be aware that who is listed as the 529 account owner impacts financial aid. Most United States colleges utilize the Free Application for Federal Student Aid (“FAFSA”) to compute how much a family can afford to pay for college—this is called the Expected Family Contribution (“EFC”). Simply, the higher the EFC, the less financial aid a student will qualify for.
When colleges analyze a 529 plan for financial aid purposes, they scrutinize the account’s ownership. If the parent owns the account, the account is considered at 5.64% of its value. When the recipient begins withdrawing from the account, the money is considered un-taxed income for purposes of filling out the next year’s FAFSA. These withdrawals will likely diminish the student/recipient’s financial aid eligibility by as much as half of the withdrawal amount.
Maximize Financial Aid Eligibility
One method of saving for college without impacting financial aid eligibility is to open a Roth IRA or qualified annuity in the student’s name. A Roth IRA, also known as an individual retirement account, allows after-tax income to be set aside at designated amounts each year. After the account owner reaches a certain age, account withdrawals and earnings are tax-free.
Roth IRA’s in the student’s name essentially function as grandparent-owned 529 investment accounts. According to the Wall Street Journal, Roth IRA’s are “not counted as assets on the FAFSA, but once you withdraw money for college, it is considered untaxed income to the student, and counted at up to 50%, even if your withdrawal is a tax-free return of Roth IRA contributions.” In the event the student chooses to not attend college, the Roth IRA can be used for “the student’s eventual retirement in a tax-advantaged manner.”
For financial aid purposes, there are many ways in which 529 plan money can be withdrawn, rolled over to the next year, or even have the account owned by the recipient’s grandparents. Learn more about 529 savings and how New York’s tax laws impact your educational investments by contacting the legal professionals at HoganWillig: 716.636.7600 or by emailing firstname.lastname@example.org.