Contributions to a 529 plan can only be made in cash. If you currently have other investments, they need to be liquidated first (with the associated tax consequence) and then the proceeds invested into the 529 plan. Establishing the account and ongoing contributions are subject to gift tax limits ($15,000 for 2019). A married couple may make a “joint gift” to the account to double the limit. The 529 plans also allow the owner to front-load the account in 1 year with up to 5 years’ worth of gift limit contributions all at once. This lump sum is treated for tax reasons as a pro-rata 5 consecutive years of contributions all at once. Any additional gifts to that beneficiary during that year and the remaining four would be subject to gift tax issues if it means the annual gift limits were exceeded. Contributions are considered a “completed gift” for gift- and estate-tax purposes even though the account owner retains an element of control. The up-front 5-year gift election is available only on 529 accounts and is a great way for parents and grandparents (hint-hint) to reduce their estates and get a significant initial balance into the account. This can come in handy for those who may have procrastinated working toward this investment goal and need to catch up.
If the beneficiary does not need all or some of the funds for qualified higher education expenses, the account owner has options: One can change beneficiary to another relative who may need the funds or keep the account going and eventually add a grandchild as a beneficiary. Graduate school expenses also are eligible. A student can have multiple 529 accounts set up in their name.
Additional tax considerations
Education Tax Credits like the American Opportunity Tax Credit and the Lifetime Learning Credit have income phase-outs that you may or may not be eligible for based on your income. Education expenses used to qualify for the tax-free withdrawal from a 529 plan cannot be used to claim these tax credits. Several states offer state income tax deductions for contributions to a 529 plan but may have eligibility limited to the in-state plan only. It is wise to look to your own state’s plan first to see if that is the case and consider that as a factor when you choose a plan right for you. Refer to your tax professional for your eligibility.
In conclusion, 529 savings plans represent a tax-free way to grow your investments for future education expenses down the road, even if you don’t have a child yet. Speak to your financial adviser to learn about plans and contribution schedules that work with your current and future investing goals.
Good sources for further information include:
- www.savingforcollege.com.
- www.irs.gov/forms-pubs/about-publication-970.
- www.finra.org/investors/saving-college.
Mr. Clancy is director of financial planning, Drexel University College of Medicine.
