Long a popular way to save for education, 529 accounts allow you to invest money for a designated beneficiary. When the student is ready, the assets can be withdrawn free from federal, and potentially state and local, taxes – as long as you use the funds to pay for what the IRS defines as “qualified higher education expenses.”
If your child is enrolled at least half-time in an eligible educational institution, you can tap a 529 for tuition, fees, room and board; books, supplies and equipment; and computers and peripherals, software, internet access and related tech services, all subject to certain limitations and requirements.
“Tuition and required fees are the biggest college bills you will probably face, but there are other eligible expenses,” says Thomas N. Psaltis, director of Education Savings Programs at Bank of America. The list of what are considered qualified includes these expenses as well:
- Student loan payments: Interest or principal on qualified education loans, up to a lifetime maximum of $10,000 per designated beneficiary (and per each sibling of the beneficiary)
- Expenses for students with special needs: Certain costs required for the student to enroll in or attend an eligible postsecondary school
- Certified apprenticeship programs: The cost of required fees, books, supplies and equipment for a registered apprenticeship program
- Postsecondary credential programs: Expenses related to a recognized postsecondary credential program, including tuition, fees, books, supplies and equipment, as well as fees for testing and continuing education required to obtain or maintain the credential
While 529 accounts offer flexibility, some costs cannot be covered with 529 assets. “Using 529 account funds, you could pay for tuition at an accredited institution for your child to get a music degree,” Psaltis says. “But if you use those funds to pay for private piano lessons, you will have to pay federal (and possibly state and local) income tax, as well as a 10% additional federal tax on the earnings portion of the money you withdraw.” You will never pay federal income tax or the additional federal tax on the principal you withdraw, regardless of what it is used for.
What happens to unused 529 funds
The rules are flexible when it comes to how many students can benefit from a single 529 account. Suppose you set aside $200,000 in an account with your child as the designated beneficiary, and you spend only half. You could change the beneficiary to a member of the beneficiary’s family, like siblings, first cousins, or even a niece or nephew.
If there is more left, it can stay in the account indefinitely. Decades later, you could name a grandchild as the beneficiary and use the remaining funds for their education. Or you could use those funds to pay for your own or your spouse’s continuing education.
How a 529 account can launch retirement savings
Another option for leftover funds is to roll 529 assets into a Roth IRA. You will face no federal taxes if the rollover is a direct trustee-to-trustee transfer and meets the following criteria:
- The 529 account has been open for at least 15 years.
- The Roth IRA is in the same name as the 529 account beneficiary.
- The rollover does not exceed the lesser of Roth IRA annual contribution limit or the beneficiary’s annual compensation (as defined by the tax code), less contributions made during the tax year to all the beneficiary’s individual retirement plans. Roth IRA income limits do not apply to a rollover from a 529 plan to a Roth IRA.
- The rollover is limited to the total 529 account contributions (and any earnings) before the five-year period ending on the date of the rollover and a lifetime limit of $35,000 per beneficiary.
Consult your tax advisor to ensure that your rollover meets all applicable requirements.
Beyond 529s: Another way to save for education
If you want to set aside money for educational activities that a 529 account does not cover, you could consider a custodial account under the Uniform Gifts to Minors Act/Uniform Transfers to Minors Act (UGMA/UTMA).
However, you cannot transfer UGMA/UTMA assets between beneficiaries. In addition, once the beneficiary of a custodial account reaches a certain age, which varies by state, they can spend the money for any purpose. UGMA/UTMA assets could also have a greater negative impact on your beneficiary’s federal financial aid package than other savings. Your tax advisor and financial advisor can help you figure out what makes the most sense for your family.
For more information, contact Merrill Lynch Wealth Management Financial Advisor Jeffery D. Price of Price & Associates at [email protected] or (817)-410-4940.
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