529 plan benefits you may not be aware of when saving for college

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These 5 things may help you better manage your family's higher education costs.

Key points

  • A 529 plan can be used to help pay for qualified higher education expenses, including expenses at a college or other accredited post-secondary school that participates in federal financial aid programs. You also can use up to $10,000 in 529 assets per calendar year per beneficiary to help pay for tuition at an elementary or secondary school.Footnote 1
  • 529 plan assets receive more favorable treatment, when a student applies for federal financial aid, than a taxable account like a UGMA/UTMA account
  • If a student receives a scholarship, the amount of the award can be withdrawn from a 529 plan without an additional 10% federal tax on earnings
  • Need help estimating college costs? Our College Planning Calculator can help.
When saving for a child or grandchild's college education, 529 plans are popular for the tax advantages and flexibility they offer. Earnings grow tax-free and, as long as the money is used for qualified higher education expenses, withdrawals — including the earnings portion of a withdrawal — are federal, and often state and/or local, income tax-free. Qualified higher education expenses now also include:
  • 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 a designated beneficiary or a sibling of the designated beneficiaryFootnote 1
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 higher education, it will have a greater 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 savings in a child's name through a custodial account, such as a UTMA/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 Transfer to Minors Act (UTMA). That's because assets in a child's 529 are owned by a parent, not the child. 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.
According to the College Savings Plans Network, for each year that a child is in college, about 5.6% of the assets held in a 529 account will be counted toward the family's expected financial contribution for college based on the federal financial calculations. By contrast, 20% of the money in a custodial account, which belongs to the child, must be counted toward the family's annual college contribution.Footnote 2

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 without incurring the 10% additional federal tax normally required on withdrawals that are not going to qualified education costs. Instead, you pay ordinary income taxes on the earnings portion of the amount returned to you. 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 beneficiary's family — for example, one of your other children or even a first cousin.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 who resides in the United States can open and fund a 529 plan. And it can be used at any accredited post-secondary 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 tax advantages

Nearly every state sponsors its own 529 plan to pay costs at accredited schools in any state. Many offer state income tax deductions to residents 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 the particular 529 plans 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."
Each year, you can contribute $15,000 ($30,000 for married couples electing to split gifts) to a 529 plan for each beneficiary without triggering federal gift taxes or exhausting your lifetime estate and gift tax exemption (for 2021) of $11.7 million per individual taxpayer ($23.4 million for married couples electing to split gifts). While contributions to 529 plans aren't deductible on your federal tax return, your investments have the opportunity to grow tax-deferred, and distributions that go to the beneficiary's qualified education costs are free from federal taxes.Footnote 1
You need to evaluate the particular 529 plans like you would any other investment.
— Richard Polimeni,
head, Education Savings Programs
Bank of America

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, while helping fund a grandchild's education. 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 — as much as $150,000 for married couples or $75,000 for individuals. Keep in mind that within the five-year period, you won't be able to make additional gifts to the beneficiary without triggering the federal gift tax or using your lifetime gift tax exemption.Footnote 4
Next steps

Footnote 1 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 withdraw 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. 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 also can 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. For distributions taken after December 31, 2018, qualified higher education expenses now include expenses for fees, books, supplies, and equipment required for the participation of a designated 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 designated beneficiary or sibling of the designated beneficiary, up to a lifetime maximum of $10,000 per individual. Distributions with respect to the loans of a sibling of the designated beneficiary will count towards the lifetime limit of the sibling, not the designated 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 Financial aid rules may change, and the rules in effect at the time the beneficiary applies may be different. For more complete information, visit the U.S. Department of Education website at www.ed.gov. The College Savings Plans Network is an affiliate of the National Association of State Treasurers and serves as a clearinghouse for information among state-administered college savings programs.


Footnote 3 The account owner can change the beneficiary to another member of the family of the original beneficiary without penalty. Please refer to the Internal Revenue Code definition of "member of the family." If assets are contributed from a UTMA/UGMA account, the custodian may not change the designated minor, except as permitted by applicable law.

Footnote 4 For 2021, individuals can gift up to $75,000 ($150,000 for married couples electing to split gifts) per beneficiary in a single year without incurring gift tax. Contributions between $15,000 and $75,000 ($30,000 and $150,000 for married couples electing to split gifts) made in one year can be prorated over a five-year period without subjecting you to gift tax or reducing your federal estate and gift tax exemption. If you contribute less than the $75,000 ($150,000 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 $15,000 ($30,000 for married couples electing to split gifts) per year. 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 $15,000 and $75,000 ($30,000 and $150,000 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 his or her gross estate for federal estate tax purposes.

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 and read it carefully. The official statement contains more complete information, including investment objectives, charges, expenses and risks of investing in the 529 plan, which you should consider carefully 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 against 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.