529 College Savings Plan Updates – SECURE Act – updated on July 10, 2020
The cost of attending college is significantly rising and outpacing inflation. Now more than ever, it is important to start saving for your children’s or your own higher education as soon as possible to reduce the amount you may have to borrow.
Updates: New legislation enacted in December 2019 made minor but impactful changes to the way 529 college savings plans can be utilized. While the advantages of a 529 plan and the core of it remain the same, the SECURE Act added two new expenses that qualify for a waiver of both tax and penalty.
The New Eligible Expenses
The first expense allows for $10,000 to be withdrawn to repay the beneficiary’s student loans. Up until now, student repayment had been an ineligible expense. The account owner may also withdraw up to $10,000 to repay student loans that belong to the beneficiary’s siblings. For example, if the account beneficiary had two siblings, then an additional $20,000 is considered a qualified 529 expense, if $10,000 is applied to each of the siblings’ loan balances.
A second addition to qualified expenses is the use of 529 funds for apprenticeships. Some parents and grandparents may be apprehensive about funding a 529 in case the child does not go to a traditional college. This option allows a withdrawal without penalty or tax if the proceeds are used to pay the fees associated with an apprenticeship program. The only stipulation is the program must be registered and certified through the U.S. Department of Labor.
Both additions have added to the flexibility and advantages of choosing 529 plans as the saving option for your children or grandchildren’s future.
Saving for College: Your Options
Ultimately, there are a few different ways to save for college, each with their own advantages and disadvantages.
Traditional savings accounts
Traditional savings accounts at banks are designed for conservative individual saving. While there isn’t much return or tax benefits to keeping your funds in a savings account, it’s a viable option for an individual hoping to build a starter savings account.
UTMA Account & Coverdell ESA Funds
Uniform Transfers to Minors Act (UTMA) account funds can be used for anything related to care for a child; therefore, can be applied to a child’s college education. The challenge of using this account is that the funds belong to the beneficiary once they reach the age of 21 and can be used freely. Thus, these funds can be contributed to post-secondary education expenses but are not specifically designed for this purpose.
A Coverdell Education Savings Account (Coverdell ESA) is a reliable option for investing in a child’s college education. However, these accounts are not often preferable to a 529 college savings plan, as a Coverdell ESA has lower contribution limits.
529 College Savings Plans
As stated above, a 529 college savings plan tends to be the most appropriate avenue to save for college, as the plan comes with different tax benefits and a parent/custodian maintains control of the assets regardless of the beneficiary’s age. The savings collected in a 529 college savings plan can also be invested in stock mutual funds, bond mutual funds, or asset allocation mutual funds, providing various options for your investments.
Each state sponsors its own 529 plan; however, you can use any state’s plan regardless of where you reside. Most states provide a state tax deduction or credit on contributions to the plan, and you won’t be taxed on the gain if it is used for qualifying education expenses.
Eligible Expenses & Institutions
Qualified expenses include:
- Tuition and fees
- Books and supplies
- Expenses for special needs services
- Purchase of a computer or software necessary for completing assignments
- Repayment of student loans
- Room and board, if enrolled at least half-time
- If the beneficiary obtains a scholarship or receives free tuition under the GI Bill, you may withdraw amounts equal to the value of the scholarship and avoid the 10 percent penalty. You still nonetheless must pay tax on the earnings
Qualified institutions included in tax-free withdrawal:
- Four-year colleges (both for undergraduate and graduate school)
- Community colleges
- Apprenticeships
- Some technical schools
- Some states allow for qualified withdrawals for K-12 private school tuition (up to $10,000 can be withdrawn each year per beneficiary)
Non-eligible Expenses
There are several items that do not qualify as education expenses, including personal living expenses, transportation to and from school, student insurance premiums, and Greek life membership dues. In the event that you withdraw contributions for non-qualified expenses, you will have to pay the income tax you avoided, as well as a 10 percent penalty on investment gain over original contributions.
Key Takeaways
A 529 college savings plan provides tax benefits and other advantages for individuals building a savings fund for higher education costs. To learn more about your options and how to start a 529 Plan, please contact a Sikich Financial professional.
