If you have children or grandchildren who will college-bound one day, then today is the day to learn about the magic of Section 529. It is more than a number. Created in 1996, the amount of money invested in Section 529 Plans have gone from $5.75 billion (with a "b") to $244 billion in 2014.
That is a lot of higher edumacation brain fuel.
Okay, Kyle, what is a 529 Savings Plan?
In a nutshell, a 529 plan lets an individual contribute after-tax dollars designated for qualified higher-education expenses. These expenses include tuition and fees, books, room and board, computers, and supplies. The distributions of these funds for qualified higher-education expenses are not subject to federal income tax.
As a result, 529 Plan investors need to understand the tax strategies that are available to them.
Many plans allow you to invest as little as $25 per month, provided you are making regular contributions.
Most states offer residents an income-tax deduction for contributions to their 529 Plan (if you live in a state with no income tax, there obviously is no deduction).
But in some states that collect income taxes, state residents are not allowed any deductions for their 529 Plan contributions.
A recent article in U.S. News & World Report, titled “The Tax Advantages of 529 Plans,” explains that the contributions to another state’s 529 Plan usually are not tax deductible.
A few states offer "tax parity" whereby account owners receive a deduction for 529 Plan contributions to any state’s program. Some states (Colorado, New Mexico, South Carolina, and West Virginia) offer a tax deduction up to the full amount of the annual plan contribution.
There are some other wrinkles regarding 529 Plans that come up.
Moving to Another State. It is not uncommon for a person to start a 529 Plan in one state and then to move to a different state. This situation can create some tax implications, especially if it is a “direct-sold” plan.
States with No Income Tax. Although there is no tax deduction "carrot" to encourage contributions, residents in states without a state income tax should still take advantage of the tax-free distribution feature of 529 Plans, according to the original article. After all, it is a chance to invest in the market, grow your investment, and enjoy those earnings tax-free when you use them for qualified educational expenses.
Other Details. The tax-free distributions are still applicable if you have to change beneficiaries. For example, what if the original beneficiary earns a scholarship and does not need the money that you saved in the 529 Plan? Typically, in these situations, there are no taxes due when you change the plan beneficiary to another person in the family.
The original article suggests that grandparents should take special note of the estate-planning benefits of 529 Plan contributions.
Since older generations often have a higher net worth than the generation with children still in school, grandparents can enjoy some great benefits. These contributions let wealthier taxpayers to take advantage of the gift-tax exclusion—money that may be annually gifted from one person to another with no federal gift tax. Be sure to ask your estate planning attorney about how this works.
Like most areas of estate planning and financial planning, great care needs to be taken to achieve the best outcomes.
I would confine your DIY projects to things like staining your deck.
Remember: “An ounce of prevention is worth a pound of cure.” When making your financial, tax and estate plans, do not go it alone. Be sure to engage competent professional counsel.
For more information about estate planning in Overland Park, KS (and throughout the rest of Kansas and Missouri) and to download free tools to help you organize your estate, visit my estate planning website.
Resource: U.S. News & World Report (December 22, 2014) “The Tax Advantages of 529 Plans”