Back-to-School Savings

Uphill. In the snow. Barefoot. Or so my parents told me. Seems like just yesterday that we all matriculated into the old alma mater as the seasons changed from the dog days of summer to the beckoning fall semester on campus. Given the fog of the coronavirus, let’s have a refresher on the 529 education account’s more nuanced details before we all head back to school.

What is a 529 Savings Plan?

The 529 is an educational savings plan where parents, grandparents, additional family members, and friends can contribute money to a beneficiary’s account for qualified educational expenses. The contributions to the plan are not deductible at the federal level; however, each state has its own sponsored plan with varying individual state tax benefits for contributions. As I currently live in Georgia, the Path2College 529 Plan is the primary option. Georgia currently offers a $4,000 state deduction per year per beneficiary for single filers (as noted by your tax return status) or a $8,000 state deduction per year per beneficiary for joint filers. For our colleagues and clients in our North Carolina office, a state benefit unfortunately does not exist. Here is a great link to check on your state of residence to find what potential tax savings await.

Quick example: 3 children each receiving an $8,000 contribution would net you a $24,000 Georgia state income tax deduction, or $1,380 in tax savings ($24,000 x 5.75%). $1,380 for 10 years’ worth of savings is almost $14,000 of additional savings!

The primary driver of using the 529 plan as a college (undergraduate and graduate degrees) savings vehicle is that the funds grow tax-free, and subsequently all future withdrawals from the plan for tuition and other qualified expenses do as well! Qualified expenses include tuition, room & board, books (are kids still using these?), computer equipment, and other supplies. However, if the funds are not used for educational purposes, the growth on the original contributions will be subject to federal and state income taxes AND a 10% federal tax liability.

How much can you contribute?

For 2021, the gift-tax free limit is $15,000 annually (the current annual exclusion amount) per donor per beneficiary, or $30,000 for parents per child. You can also supercharge your contributions up to a five-year limit for a $75,000 one-time contribution, or $150,000 if funded by both spouses! Supercharging contributions is a great estate planning technique worth consideration. Maximum contribution amounts do come into the fold though and vary state by state. The range is wide from $225,000 to $542,000 for New Hampshire. A great resource for referencing all state limitations, tax benefits, and plan offerings is savingforcollege.com which can help you navigate based on state residence. You are not bound to invest in the plans for your respective state but doing so may forgo some tax savings benefit as outlined above.

What are expenses are qualified?

Once your child reaches the best four years of their lives, it’s time to start spending the money! You can request funds via phone or online with different types of distributions – either to yourself or to the educational institution itself. I would recommend paying tuition and room and board directly to the school from the 529 plan itself. If your child lives off-campus (renting a house, apartment, or even at home), you will need to obtain the cost of attendance (COA) for the school’s room and board allowance from the college website or financial aid department. The qualified room and board costs for off-campus living must be less than or equal to what is included for school’s official cost of attendance, so unfortunately upgrading the TVs and aquarium are out of the question. For less hefty purchases like books, internet, computers, etc., simply call up your 529 plan to request a reimbursement be made for expenses incurred. However, the onus is on you to keep all receipts for tax purposes. 529 plans will not ask for verification when you ask for reimbursements for these expenses, but the IRS may. I have one last reminder to keep in the back of your mind: be sure to request reimbursements in the same calendar year that you incurred the expense, otherwise it will be considered nonqualified. We encourage our clients to leverage the Vault on our Balentine Blueprint to organize their digital receipts, much like they use it to securely store important documents like their estate plan, income tax returns, marriage certificates, and other pertinent family documentation.

What if I have leftover funds?

People frequently ask about leftover funds should their children receive scholarships or if they happened to overfund the 529 plan. The rules are flexible in allowing you to change beneficial ownership to a family member which broadly includes spouses, siblings, stepchildren, nieces or nephews, aunts and uncles, first cousins, parents, and children-in-law. As always, please check with the plan provider before making any changes to the beneficiaries as modifying to a non-family member will result in a nonqualified distribution. As discussed before, nonqualified distributions will result in federal and state income tax on any earnings AND a 10% federal tax penalty.

During the Tax Cuts and Jobs Act of 2017, 529 plans were amended to include provisions such as permissible withdrawals up to $10,000 annually for K-12 tuition at a public, private, or religious school. The Secure Act of 2019 also allowed the one-time ability to withdrawal up to $10,000 to pay off any qualified financial aid loans for a single beneficiary and $10,000 for each of the beneficiary’s siblings. Over time, more and more flexibility has been built into the 529 savings program to help encourage Americans to save for their family’s educational future.

Could you explain fees and investment options?

Investment options are specific to the individual state providers but are similar in construction to most modern 401(k) plans in that they offer age-based options based on expected year of matriculation. As the beneficiary ages toward enrollment, the underlying asset allocation divests itself of equities and moves to safer, less volatile assets in anticipation of upcoming expenditures (hello tuition bill!) and decreasing years of time to compound earnings. Fee compression has been welcomed to the 529 world now as well which should help prevent you from spending too much time shopping plans and more time saving.

How can I begin contributing?

Fortunately for you, there will be no pop-quiz, but your Balentine Relationship Manager can help answer and clarify any questions you may have. Like almost all great investment foundations the secret to successful educational planning for your family is…to begin.

Pencils now sharpened, notes digested, let’s get going. What’s that you say? Kids aren’t using pencils anymore?

Well when I went to school…