Helping to fund future education expenses for our children and grandchildren is one of the most rewarding ways to give. When planning ahead for this type of gift, one special account type stands out: the 529 plan.
Tax Advantages
- Tax-Free Growth: Investments can grow tax-free.
- Tax-Free Withdrawals: Most education-related expenses are considered ‘Qualified’, meaning that the withdrawals used for them are tax-free. It’s important to understand what expenses are considered qualified and, therefore, are not subject to taxation upon withdrawal.
- Contributions and Earnings: For ‘NON-Qualified’ withdrawals (withdrawals that don’t qualify for tax-free withdrawals), you don’t have to pay taxes or penalties on the portion of the account withdrawal that represents the original contributions. Only the earnings portion of non-qualified withdrawals will be subject to taxes and a 10% penalty. (However, you may not take a basis-only 529 plan withdrawal. When funds are withdrawn from a 529 plan, the distribution is allocated pro rata between earnings and basis.)
- Documentation: Keep detailed records of withdrawals and receipts. It is usually recommended to keep this all organized in a digital file for future reference. (And keep a backup to that folder)
High Contribution Limits
- Contribution limits vary by state: Because the contribution limits are high, in my experience, they don’t come into play for most families.
- Annual Gift Tax Exclusion: A good way to gift funds into a 529 plan is to stay under the annual gift tax exclusion amount of $18,000 per recipient per year (or $36,000 for married couples). Even if you go beyond that number though, there is still a lifetime exclusion that you can possibly take advantage of. (I know, it’s a little confusing, just give us a call if you’d like a further explanation)
- Lump Sum Contributions: You can combine 5 years’ worth of contributions into one single year and still get the annual gift tax exclusion. (Up to $90,000 per individual. Or $180,000 for married couples). 5 years’ worth of gift tax exclusions can be combined into one year. This is specific to 529 plans.
Control and Flexibility
- Account Owner Control: Control over investment choices and withdrawals.
- Beneficiary Changes: Can change beneficiaries to another family member.
State-Specific Benefits
- Tax Deductions/Credits: States offer deductions or credits for contributions for in-state residents. (Which is why it may make sense to open a plan in the state you live in)
Planning Ahead
- Start Early: Early contributions increase the potential for compound growth. Compound growth is the rate of growth over a given time period.
- Regular Contributions: Small, consistent contributions can increase the growth over time.
A New Strategy
- Roth Conversion from 529: A 529 account that has been open for at least 15 years can now be converted into a Roth IRA for the beneficiary. This now means that you can give your child/grandchild a head start on education AND their retirement in the same account. The old rules that didn’t allow this conversion may have made people cautious of overfunding a 529 account, this is now less of a consideration, but now that is less of a consideration. There are some specific guidelines that need to be followed though, so give us a call if you have any questions.
Like many aspects of finance, planning ahead can make all the difference.
On the lighter side, I am 50-50 on wins and losses with Elliott in chess this week. I was also ranked by AdvisorHub on the list for the year 2023.
Hope all is well with you and your family,
Jeremy
Jeremy Finger applied for the award by submitting responses to a questionnaire for the award committee’s consideration. No compensation was paid to be considered for the award. For more information about the award, please see www.advisorhub.com.
Finger Financial Five – 5 points in 5 minutes or less – is to provide you with a weekly shot of useful financial information. My intention is to share principles so that you will have more clarity that help you make better financial decisions.
Investment advice is offered through Stratos Wealth Advisors, LLC, a registered investment advisor. Stratos Wealth Advisors, LLC and Riverbend Wealth Management are separate entities.
The information presented in this newsletter is the opinion of the writer and does not reflect the view of any other person or entity. The information provided is believed to be from reliable sources, but no liability is accepted for any inaccuracies. This is for information purposes only and should not be construed as an investment recommendation.
Past performance is not necessarily indicative of future results, and there is no assurance that the investment objective will be achieved or that the strategies employed will be successful. All investments involve risk and, unless otherwise stated, are not guaranteed.
The information in this material is not intended as tax or legal advice. Please consult legal or tax professionals for specific information regarding your individual situation.
The numbers quoted in this post are relevant for 2024 and may be different in future years.
