6 lesser-known benefits of 529 plans

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These 6 things may help you better manage your family's education costs.

Key points

  • A 529 plan can be used to help pay for qualified education expenses,Footnote 1 including expenses at a college or other accredited postsecondary, private elementary or secondary school that participates in federal financial aid programs
  • When a student applies for federal financial aid, 529 plan assets receive more favorable treatment than other student-owned assets such as an UGMA or UTMA account
  • If a student receives a scholarship, the amount of the award can still be withdrawn from a 529 plan tax-free if used for qualified education expenses or without an additional 10% federal tax on earnings if used for non-qualified expenses
  • You can always repurpose some or all of a 529 plan's funds if unused
When saving for a child or grandchild's college education, 529 plans are popular for the tax advantages and flexibility they offer. Earnings grow federal tax-free and, as long as the money is used for qualified education expenses, withdrawals — including the earnings portion of a withdrawal — are federal and often state and/or local income tax-free. Qualified education expensesFootnote 1 also include:
  • Up to $10,000 per year per beneficiary to help pay for tuition in connection with enrollment or attendance at an eligible elementary or secondary public, private, or religious school (state tax treatment may vary)
  • Expenses for fees, books, supplies and equipment required for the participation of a designated beneficiary in a registered and certified apprenticeship program
  • Payment of student loans up to a lifetime maximum of $10,000 for the designated beneficiary or a sibling of the designated beneficiary (the lifetime maximum applies separately for the designated beneficiary and sibling of the designated beneficiary)
Below you'll find lesser-known 529 plan benefits worth considering as you save for college.

1. 529 plan assets won't disqualify your child from financial aid

"Often, people mistakenly believe that because a 529 plan account is earmarked for education, it will have a negative impact on financial aid eligibility," says Richard Polimeni, head of Education Savings Programs at Bank of America. "In fact, a 529 plan is treated more favorably in the federal financial aid formula than saving in a child's name through a custodial account, such as an UTMA or UGMA," which are commonly used accounts for minors that are named after the acts that established them: the Uniform Gift to Minors Act (UGMA) and the Uniform Transfers to Minors Act (UTMA). That's because assets in a 529 plan are typically owned by a parent, not the child. 529 assets only count as 5.6% of assets for purposes of the financial aid calculations, compared to UGMA or UTMA accounts at 20%.Footnote 2 When calculating how much the family is expected to contribute, the Free Application for Federal Student Aid (FAFSA) specifies that assets belonging to parents are tapped at a lower rate than those held in a child's name.

2. If your child 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 gift by earning a "full ride" or substantial scholarship toward college. In those cases, you can withdraw an amount equal to the scholarship from the 529 plan and only pay ordinary income taxes on the earnings portion of the withdrawal. You do not incur the 10% additional federal tax normally required on withdrawals that are not going to qualified education expenses. Consider using that money to help you meet other financial goals, such as saving for retirement.
You also can give those unneeded 529 plan assets to another relative to use for college. It's as simple as changing the name of the account's beneficiary to someone in the 529 designated beneficiary's family — for example, one of your other children or even your child's first cousin — without adverse income tax consequences.Footnote 3

3. You can use a 529 plan to fund your own continuing education

Anyone age 18 or older with a Social Security number or taxpayer identification number who resides in the United States can open and fund a 529 plan account (refer to the state's 529 plan rules to confirm your eligibility). And it can be used at any accredited postsecondary institution, including technical and vocational schools. It can be a great way to start saving for further training for your current career or a new one you are considering.

4. Investing in a 529 plan sponsored by your home state can bring you additional potential tax advantages

Every state — and the District of Columbia — sponsors its own 529 plan to pay costs at accredited schools in any state. Many states offer state income tax deductions to residents and taxpayers contributing to their home state's plan. "It's important to consider any benefits available in your home state," says Polimeni, "but you need to evaluate a particular 529 plan's features like you would any other investment. Look at the plan's investment manager, investment choices, plan performance and underlying fees and expenses before you invest."
You need to evaluate the particular 529 plan's features like you would any other investment.
— Richard Polimeni,
head, Education Savings Programs
Bank of America

5. You can give more efficiently and transfer wealth with a 529 plan

Contributing to a 529 plan also can help grandparents or others reduce the size of their taxable estates while helping fund a grandchild's education. Each year, you can contribute a certain amount to a 529 plan for each beneficiary without triggering federal gift taxes or using your lifetime estate- and gift-tax exemption. The amounts you can contribute as well as the exemption can change annually. The latest information can be found in our Annual Limits Guide (PDF). While contributions to 529 plans aren't deductible on your federal income tax return, the investments have the opportunity to grow tax deferred, and distributions that go to the beneficiary's qualified education expenses are free from federal taxes.Footnote 1
It's even possible to accelerate your gifting timetable by contributing five years' worth of annual exclusion gifts per beneficiary to a 529 plan in one year using the annual federal gift tax exclusion. Keep in mind that within the five-year period, you won't be able to make additional gifts to the beneficiary — whether the gift is a contribution to a 529 plan or any other form of gift — without triggering the federal gift tax or using your lifetime gift exemption.Footnote 4

6. Unused funds may be able to go toward retirement

There's always the possibility that the beneficiary of a 529 plan may not need all the funds in the account for education expenses. Under new legislation, a portion of the 529 assets can be rolled over to a Roth IRA federal income tax and penalty free in the beneficiary's name, subject to eligibility criteria. This flexibility can provide an opportunity to help jump-start a beneficiary's retirement savings. After rolling over the funds to a Roth IRA, the funds can be used for anything, not just qualified education expenses, without being subjected to federal taxes, assuming you meet criteria for a tax-free Roth IRA withdrawal.

Next steps

To be eligible for favorable tax treatment afforded to the earnings portion of a withdrawal from a section 529 account, such withdrawal must be used for "qualified higher education expenses," as defined in the Internal Revenue Code. The earnings portion of a withdrawal that is not used for such expenses is subject to federal income tax and may be subject to a 10% additional federal tax, as well as applicable state and local income taxes. The additional tax is waived under certain circumstances. Qualified higher education expenses include tuition, fees, books, supplies and equipment required for enrollment or attendance of the beneficiary at an eligible educational institution; certain room and board expenses; special needs services incurred in connection with enrollment or attendance at an eligible educational institution; and computers or peripheral equipment, computer software, or internet access and related services that are to be used primarily by the beneficiary during any of the years the beneficiary is enrolled at an eligible educational institution. The beneficiary must be attending an eligible educational institution at least half time for room and board to be considered a qualified higher education expense, subject to limitations. Institutions must be eligible to participate in federal student financial aid programs. Some foreign institutions are eligible. You can also take a federal income tax-free distribution from a 529 account of up to $10,000 per calendar year per beneficiary from all 529 accounts to help pay for tuition at an elementary or secondary public, private or religious school. Qualified higher education expenses include expenses for fees, books, supplies and equipment required for the participation of a beneficiary in an apprenticeship program registered and certified with the Secretary of Labor under the National Apprenticeship Act and amounts paid as principal or interest on any qualified education loans of the beneficiary or sibling of the beneficiary, up to a lifetime maximum of $10,000 per individual. Distributions with respect to the loans of a sibling of the beneficiary will count toward the lifetime limit of the sibling, not the beneficiary. Such repayments may impact student loan interest deductibility. State tax treatment may vary for distributions to pay for tuition in connection with enrollment or attendance at an elementary or secondary public, private or religious school; apprenticeship expenses; and payment of qualified education loans.
Footnote 2 This is based on current interpretation of federal financial aid rules. Financial aid rules may change, and the rules in effect at the time the beneficiary applies may be different. For more complete information, please go to the Go to third-party website Department of Education's website popup.

Footnote 3 The account owner can change the beneficiary to another member of the family of the original beneficiary without incurring federal and generally state and local income tax. Please refer to the Internal Revenue Code section 529(e)(2) definition of "member of the family." If assets are contributed from an UTMA or UGMA account, the custodian may not change the designated minor except as permitted by applicable law.

Contributions during 2024 between $18,000 and $90,000 ($36,000 and $180,000 for married couples electing to split gifts) made in one year can be prorated over a five-year period without subjecting you to federal gift tax or reducing your federal unified estate and gift tax credit. If you contribute less than the $90,000 ($180,000 for married couples electing to split gifts) maximum, additional contributions can be made without you being subject to federal gift tax, up to a prorated level of $18,000 ($36,000 for married couples electing to split gifts) per year. Federal gift taxation may result if a contribution exceeds the available annual gift tax exclusion amount remaining for a given beneficiary in the year of contribution. For contributions between $18,000 and $90,000 ($36,000 and $180,000 for married couples electing to split gifts) made in one year, if the account owner dies before the end of the five-year period, a prorated portion of the contribution may be included in their estate for federal estate tax purposes. Please consult your tax and/or legal advisor for guidance.
NOTE: Certain states may offer tax or other benefits for investing in their Section 529 plan. Some states may reduce or eliminate those benefits for investments in Section 529 plans administered by a state other than your home state or your beneficiary's home state. It is important to carefully consider any benefits available in your home state (or the home state of your designated beneficiary) along with a plan's investment manager, investment options, plan performance and underlying fees and expenses prior to investing. Certain states also may require the recapture of all or part of previously claimed tax benefits if the proceeds are not used for qualified higher education expenses (as defined by the federal tax law) or if the assets are transferred to another state's Section 529 plan.

Please remember there's always the potential of losing money when you invest in securities.

Merrill, its affiliates, and financial advisors do not provide legal, tax, or accounting advice. You should consult your legal and/or tax advisors before making any financial decisions.
Before you invest in a Section 529 plan, request the plan's official statement from your Merrill Financial Solutions Advisor and read it carefully. The official statement contains more complete information, including investment objectives, charges, expenses and risks of investing in the plan, which you should carefully consider before investing. You should also consider whether your home state or your designated beneficiary's home state offers any state tax or other state benefits such as financial aid, scholarship funds and protection from creditors that are available only for investments in such state's 529 plan. Section 529 plans are not guaranteed by any state or federal agency.