529 plans can be a huge “utility” tool in a portfolio. In addition to funding education, 529 plans can be a tax savings tool and gifting /estate planning tool.
What are they?
529 Plans were designed as a college savings vehicle with unique tax benefits. They were created in 1996 to encourage parents to save for their children’s college expenses. 529 refers to the section of the federal tax code that the plan falls within. It is important to note that 529 plans were initially intended for higher education only. This meant that the accounts could be used for qualified expenses for trade, technical and specialty schools, community colleges, certificate programs, four-year universities and colleges, graduate school, law school, and medical school.
Effective in 2018, 529 plan funds became available to use for K-12 tuition with the following stipulations.
529s are funded with after-tax dollars. In some states, like Illinois, a tax deduction is received for contributions made each year. In Illinois, taxpayers are eligible for a state income tax deduction of up to $10,000 per individual ($20,000 for married couples).
Funds grow tax-deferred and can be withdrawn tax-free if used for a qualified education expense (which we will define below). If funds are withdrawn for non-qualified expenses (or for any other reason), there is a 10% penalty and tax owed on the growth/earnings of the account.
All states and the District of Columbia have their own 529 plan. They are typically managed by a mutual fund company or bank. It is possible to open an account in a different state than the one you reside in, but one should be aware of the specific tax benefits that can be lost. And, yes, you can roll an account from one plan to another.
How do they work?
Getting started is easy. If you are a resident of Illinois, go to the Bright Start home page to open an account. Anyone can be the owner, but only one child or person can be the beneficiary. You can choose whether to contribute regularly or to make a one-time contribution. If you are a resident of another state and want any tax incentive offered by that state, you will want to look up your state’s plan name and go to that website. In most states there are no restrictions on residency or in what state the beneficiary attends college.
Other people can make contributions too. 529 plans are a great opportunity for grandparents, other family members, and even friends to make gifts towards a child’s college fund. They can make up to $16,000/yr/pp or $32,000 per married couple without triggering a gift-tax form. Another estate planning benefit includes making a 5-year front-loaded gift. In other words, an individual can contribute $80,000 in 2022, which will cover the next five years’ gifts on behalf of a grandchild, niece, nephew, or family friend. Likewise, a married couple could contribute $160,000 as a 5-year front-loaded gift.
In addition, the assets can be transferred tax-free to other immediate family beneficiaries for their education, thereby offering the possibility of funding education across multiple generations.
Once an account is open and funded, it is time to make an investment choice.
How are funds invested?
Funds are invested according to your desired risk appetite. Bright Start uses eleven mutual fund families and offers target date, individual, and age-based options. Fortunately, Bright Start has one of the lower expense plans available.
What education expenses are covered?
529 rules generally refer to covered expenses as “qualified”. The following expenses are eligible for 529 reimbursement:
What are the benefits?
There are significant financial benefits for a 529 plan. If used appropriately, it is a tax-free college savings tool. The maximum account balance in an Illinois 529 plan is $500,000.
529 plans can also be excellent estate planning tools. Not only can gifts be made as mentioned above, but larger contributions can be made (with gift-tax) that potentially can reduce the size of a taxable estate.
What happens if there is money left over or the child chooses not to attend college?
There are several options:
If you think a 529 account is a good plan for you and want to talk it over with Jenifer, please, call her at 773-425-6790 or schedule a meeting by clicking here.