UPDATE: In December 2019, the SECURE Act became law

• Retroactive to the start of 2019, 529 plans may be used to pay off qualified student loans, up to $10,000 per person
• In addition, up to $10,000 per person may be used to pay off student loan debt for any sibling of the beneficiary
• 529 plans may also be used to pay for Apprenticeship Programs

Contribute to a tax-advantaged 529 account

If one of your financial goals is to save for college for a child, grandchild, or friend, one of the best ways is through a 529 account (also called a QTP or Qualified Tuition Program). These accounts behave a bit like Roth IRAs: after-tax money is contributed, grows tax-free, then comes out tax-free, as long as it’s used for Qualified Education Expenses.

A Qualified Education Expense includes tuition and fees at a post-secondary school, such as a college, university, trade school, or apprenticeship program. Other Qualified expenses include required books, supplies, equipment, room and board (if at least half-time), plus computer, computer software, and internet access.

The recent tax change temporarily expanded this definition: now K-12 education is also eligible. Up to $10,000 annually can be used from a 529 account to pay for tuition expenses for kindergarten through grade 12. (However, not all states have updated their guidelines.)

(Keep in mind that the K-12 education provision *may* go away after 2025.)

There are two types of QTPs: Prepaid Tuition Plans and College Savings Plans. As the name suggests, the prepaid tuition plan allows you to lock in tuition at your favorite institution years ahead of time. However, Junior might not necessarily wish to attend your alma mater.

College Savings Plans are more popular due to their flexibility. Every state has at least one program, and sometimes several. You don’t necessarily need to be a resident of a state to participate in their plan. In other words, you have over fifty choices!

However, some states offer state tax deductions, so review your own state’s program first. You can live in Minnesota, participate in California’s program, and ultimately send Junior to a school in Oregon.

Like any investment vehicle, don’t forget to review the fees.

Play Santa Clause

The usual amount that is contributed to a 529 account is the annual gift tax exclusion of $15,000. In other words, if you feel like playing Santa Clause you can gift $15,000 to as many people as you like every year without any tax consequences. By contributing to a 529 account for the benefit of someone else (the beneficiary) you are “gifting” them money. Likewise, if you have several 529 accounts for several children (or grandchildren) you can contribute $15,000 to each of them.

You have the option of “front-loading” a 529 account with $75,000, which counts as your $15,000 gift this year, plus the next four years ($15K x 5 years = $75K). This would be a great way to give more money more time to grow tax-free.

If there’s two of you (two parents or two grandparents) all the above numbers double. As a couple, you can place up to $150,000 into your child’s 529 plan today.

You can always go above the annual gift tax exclusion, but you’ll be eating into your lifetime gift tax exclusion of. . . wait for it. . .over $11.5 million dollars (over $23 million for couples).

In other words, during your lifetime (and after death) you may currently gift up to $11.58 million without any tax consequences. This is in addition to the $15,000 annual gift exclusion or any charitable donations. Note, that your state may have a different rule with regard to state taxes, so keep that in mind.

Photo by Steve Shreve on Unsplash

Over fifty choices!

I live in California, and can contribute as little as $25, but not more than $475,000. This plan has low fees and a broad range of investment portfolio choices to match any risk tolerance.

Minnesota has a $25 minimum and $425,000 maximum contribution. Minnesotans may be eligible for state tax deductions, up to $1500 for single or $3000 for MFJ. (For this reason, our Minnesotan in the example above probably should have their account here, rather than California.)

Oregon has two plans to choose from, either sold directly or through an advisor. Contributions range from $25 minimum to $310,000 maximum (Plan 1), or $250 – $305,000 (Plan 2). Fees and investment choices vary.

Check out your favorite state here. . .

Change your mind and don’t like your Plan? You can always roll it over to a different state plan. (However, you may owe state taxes if you initially enjoyed a deduction.)

Plays nice with financial aid

Another advantage of 529 plans is that they work well with financial aid. When your child applies for financial aid, 529 accounts are counted as your assets, as the parent (or grandparent), not your child’s assets. As the parent, only 5.64% percent of your assets above $20,000 is counted when calculating financial aid eligibility. As a grandparent, 0% of your assets are counted.

In addition, 529 distributions during college are not counted as part of a student’s income if they come from the parent’s 529 account. (However, they are counted if they come from someone else’s 529 account, such as a friend or grandparent.)

What if Junior doesn’t use up his 529 plan? (Or drops out!) Plans can be transferred to any family member of the beneficiary (including yourself).

Another nice benefit with the new tax law: 529 plans can now be transferred to ABLE accounts for the disabled. (Although this provision may also go away after 2025.)

Student loan debt? No problem, up to $10,000 per beneficiary can be used to repay this debt.

In addition, up to $10,000 per person for each sibling of the beneficiary can also be used to pay off student loan debt.

There is no deadline for using the money. If transferring the plan to another college-bound family member isn’t practical, you, the account owner, can still make a withdrawal at any time.

However, if the money is not used for Junior’s Qualified Educational Expenses, taxes on the earnings plus a 10% penalty apply. (But no penalty or taxes on the portion of the withdrawal that came from your original investment.)

Depending on the length of time the account has grown (eg, many many decades) and your tax bracket, that 10% penalty could be covered by the earnings. Your financial advisor will need to do the math.

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Contribute to a tax-advantaged Coverdell account

Another savings vehicle is the Coverdell Education Savings Account (ESA). This one is more limited in that you can only contribute $2000 annually per beneficiary (future student), and zero if the beneficiary is over the age of 18. Note, the beneficiary can only receive $2000 annually regardless of how many family members set up ESAs for them.

You also can’t contribute if your AGI is ≥ $110,000 ($220K for MFJ).

Tax benefits are the same as QTPs: money grows tax-free and comes out tax-free if used for Qualified Educational Expenses.

ESA’s can also be used for elementary or secondary education, and unlike 529’s, are not limited to $10,000.

ESAs may be set up at any financial institution that supports them. Therefore, you have much more control over investment choices.

Considering the ridiculously high cost of secondary education, $2000 a year is not much. However, if you started this at the birth of your child, giving it 18-20 years to grow, this may be something to consider.

You may contribute to both a QTP and a Coverdell in a given year.

Contribute to an IRA account

Your IRA is intended to be used for your retirement, however, you are allowed to take out money prior to age 59½ if it’s used for higher education expenses for either yourself or a family member. (In this instance “family member” is defined as yourself, spouse, your children, or grandchildren.)

Note, once you take money out of your IRA you can’t put it back. . . So, this is not the ideal vehicle for college savings.

In summary, 529 plans allow you to contribute and save tax-free—up to the state limit—for qualified education expenses for as many college-bound people as you can afford. There are no income or age restrictions for either you or the account beneficiaries.

Good luck!

Related articles of interest

• Teens: Start Investing Today in a Roth IRA. At what age should kids start investing?

• Index Fund Investing for Beginners. Get started saving for your long-term financial goals

• What’s the ROI of your College Degree? Strategy for the college-bound.

Top photo credit: Photo by rawpixel.com from Pexels

This information has been provided for educational purposes only and should not be considered financial advice. Any opinions expressed are my own and may not be appropriate in all cases. All efforts have been made to provide accurate information; however, mistakes happen, and laws change; information may not be accurate at the time you read this. Links are included for reference but should not be considered an implied endorsement of these organizations or their products. Please seek out a licensed professional for current advice specific to your situation.