Learn about the advantages these plans have to help you pay for college
From the Merrill Edge Minute e-newsletter.
- Funds saved in a 529 plan can be used to help pay for expenses at a college or other accredited post-secondary school that participates in federal financial aid programs.
- 529 plan assets receive more favorable treatment than savings in other taxable accounts, such as a UGMA/UTMA account, when applying for federal financial aid.
- If a student receives a scholarship, the amount of the award can be withdrawn from a 529 plan without a 10% additional federal tax on earnings.
A Section 529 college savings plan can be a great tax-advantaged way to save for an education — your children's, your own or anyone else's — and it may offer surprising financial flexibility.
If you establish a 529 plan to pay for college or for graduate or vocational school, you may be able to take advantage of federal and possibly state income tax benefits. Earnings in a 529 account can grow tax-free, and withdrawals, including any earnings are federal and possibly state income tax free, as long as the money is used for qualified higher education expenses.1
Opening and contributing to a 529 plan could be crucial in helping a student afford college. "Every dollar you put aside now is one dollar less you have to find, or borrow, later," says Richard J. Polimeni, director, education savings programs, Merrill Lynch.
Here are 5 hidden ways to benefit from 529 plans.
1. A 529 account can provide you with favorable treatment when applying for federal financial aid.
"Often, people mistakenly believe that because a 529 plan account is earmarked for higher education, it will have a negative impact on financial aid eligibility," says Polimeni. "In fact, investing for college with a 529 plan is treated more favorably in the federal financial aid formula than saving in your child's name through a custodial account, such as a UTMA/UGMA." In general, financial need is defined as the difference between the total cost of college and the expected family contribution. Assets in a 529 plan for a minor child are owned by a parent, and according to federal financial aid formulas, parents' funds are tapped at a lower rate than those held in a child's name when it comes to calculating the expected family contribution. According to the College Savings Plans Network, during each year that a child is in college, parents are expected to contribute about 5.6% of the assets saved in a 529 college savings plan account. In contrast, 20% of the money saved in a custodial account, such as an UTMA/UGMA, which belongs to the child, must be counted toward the family's contribution to college each year. 2
2. If the student gets a scholarship, you can repurpose some or all of the 529 plan funds.
Your straight-A student or basketball star may give you an unexpected cash gift by earning a college scholarship. You can withdraw an amount equal to the scholarship from the 529 plan without incurring the 10% additional federal tax that is normally required on withdrawals that are not used to pay for higher-education costs. You would only have to pay ordinary income tax on any earnings on the amount returned to you. That money can be used to help you meet other financial goals, such as saving for retirement.
Another option is to give those unneeded 529 plan assets to another relative to use for college. You can change the account's beneficiary to a member of the family of the person for whom the account was originally intended — for example, one of your other children or even a first cousin.3
3. You can use a 529 plan to fund your own education.
Funds in a 529 plan can be used at an accredited post-secondary institution — including technical or vocational schools — to help pay for higher education. And, anyone age 18 or older with a social security number and residing in the U.S. can open and fund an account. You can open an account for yourself, or open or contribute to one for someone else, including nonrelatives. It's a great way to pursue training for your current career or a new career for which you previously did not have the resources.
4. Contributing to a 529 plan could bring you a significant tax advantage.
Nearly every state sponsors its own 529 plan, which can be used to pay costs at accredited schools in any state, and many offer a deduction on state income tax to residents who contribute to their home state's plan. "It's important to consider any benefits available in your home state, but you need to evaluate a particular 529 plan like you would any other investment," says Polimeni. "You'll want to look at the plan's investment manager, investment options, plan performance and underlying fees and expenses before you invest."
Each year you can contribute $14,000 ($28,000 per married couple) to a 529 plan for each beneficiary without triggering federal gift taxes or using your lifetime estate- and gift-tax exemption of $5.34 million per individual tax payer. While contributions to 529 plans are not deductible on your federal tax return, the investments have the opportunity to grow tax-deferred, and distributions to pay for a beneficiary's college costs are federally tax-free, as long as withdrawals are used for qualified higher-education expenses.1
Investing for college with a 529 plan could be more beneficial than saving in your child's name through a custodial account, such as a UTMA/UGMA.
5. You can transfer wealth with a 529 plan.
Contributing to a 529 plan also can help grandparents or others reduce the size of their taxable estates. They can even accelerate their gifting timetable by combining five years of 529 plan contributions of as much as $140,000 per couple (up to $70,000 for individuals) in one year, per beneficiary, using the annual gift exemption. Keep in mind that within the five-year period you would not be able to make any more taxable gifts to the beneficiary.4