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Back to School, Back to Savings: 529 Plans as a Strategy

Aug. 29, 2022, 8:45 AM

Delightful summer days—where kids stay up late and sleep in, worrying only about which video game to play or if they put on enough sunscreen at the pool—are coming to an end as students around the country head back to school. As our clients start to check off items on their back-to-school purchase list and adjust to the change in routine, now is a great time to advise them on saving for education to better their family’s future.

In addition to education-related tax credits and state sales tax holidays for back-to-school expenses, Section 529 education savings plans can be an excellent tool to position a family for success.

Rising Educational Costs and the Need to Save Early

Like food, housing and almost every other expense, educational costs are 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 private university tuition. This doesn’t include books or room and board. Plus, more students are needing higher-level degrees and certifications to land the jobs they want.

Simply put, education is often one of the biggest investments parents will make for their children. Saving today can soften the financial blow.

529 Education Investment Plans

Section 529 plans are education savings plans that can be used toward higher education expenses for the account beneficiary. Account owners get tax benefits, flexibility, and control.

When clients open a 529 account, they must select a beneficiary for whom all of the funds will be used to cover their qualified 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.

Tax Benefits

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, and so on. 529 plans usually are invested with age-based funds, meaning that the asset allocation typically adjusts from an aggressive strategy to a more conservative one as the student nears college. The funds grow tax-free until a client needs them to pay for education expenses. The distributions then come out tax-free, assuming they are used to pay for qualified education expenses.

And though there is no federal deduction for contributions to a 529 plan, there are some state tax benefits to lower taxes. Many states offer a 529 tax benefit in the form of either a deduction or credit, allowing clients to decrease their state income tax burden.

Qualified Education Expenses

529 funds must be used for qualified education expenses for all withdrawals to be tax-free. Some examples of qualified education expenses include:

  • Tuition and fees
  • Books and required school supplies
  • Room and board (with some stipulations)
  • Computers and related equipment such as printers

Expenses for Elementary and Secondary Education

Additionally, up to $10,000 per beneficiary per year can be withdrawn to cover K-12 private or religious schools, thanks to the Tax Cuts and Jobs Act, signed into law in December 2017. Practitioners should check state rules before advising their clients to make sure the state follows the expansion.

It might be worthwhile to advise clients to keep track of the funds separately for both college and K-12 expenses, as the educational needs are on different timelines. Matching investment strategies to meet the demands of the timeline is crucial to the overall educational expense strategy and is an area practitioners will be relied on for advice.

Estate Planning

Wealthy families may benefit from “super funding” 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 front-load their contributions without having to pay gift taxes, while keeping their lifetime gift and estate tax exemption.

This means that a client could contribute five times the annual gift tax exclusion as an upfront contribution. The annual exclusion is $16,000 in 2022 ($32,000 for married couples). Therefore, a client could front-load $80,000 ($160,000 for married couples) to “super fund” a 529 plan. This is an excellent way to get more money in the 529 plan quickly so that it grows longer, and it keeps money out of the estate.

Practical Tips and Considerations

CPAs and advisers should encourage clients who are parents to consider opening a 529 plan when their children are very young to tap into the most potential 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 advise their clients that, if financially feasible, super funding a 529 plan can also be wise for parents who decide to send their children to private K-12 schools. Often, parents of young children haven’t had a long time for contributions to grow. However, if the parents (or grandparents) front-loaded the contributions, they could yield better financial results. Shifting money to investment accounts that grow tax-free can ease some of the burden of the tuition expenses.

Keep in mind that though a client must select a beneficiary, they can always change that beneficiary if they need to. For example, if a client has two children and one child chooses not to go to college, the client could transfer the funds to the child who goes to college.

And we all know life challenges happen, and clients sometimes have to tap into emergency funds. Contributions to a 529 plan are made with after-tax money, which means account owners can withdraw any part of their original contributions without taxes or penalties—a 10% penalty only applies to the gains on the account).

Check out IRS Publication 970, Tax Benefits for Education, for additional guidance on education credits, savings plans and more. The AICPA’s Tax Section Odyssey podcast series also offers insights on various tax and planning topics.

Enjoy the Last Days of Summer

Soon, school buses will be part of everyone’s morning commutes, and nights will be filled with homework and earlier bedtimes. Enjoy the end of summer while keeping a pulse on your clients’ long-term financial plans.

This article does not necessarily reflect the opinion of The Bureau of National Affairs, Inc., the publisher of Bloomberg Law and Bloomberg Tax, or its owners.

Author Information

Susan Allen, CPA/CITP, CGMA, is a senior manager on the American Institute of Certified Public Accountants’ Tax Practice and Ethics team. She drives content strategy to ensure members receive the guidance and support they need to remain the premier providers of tax services.

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