Understanding the “Gift” of a 529 Education Savings Plan– February 19, 2019 by Rachel Roan

Up until the Tax Cuts and Jobs Act passed in 2017, many taxpayers used 529 education savings plans as a tax-free way to save for their children’s or other beneficiaries’ college education. However, beginning January 1, 2018, those funds can be used for any qualified educational expenses, including elementary and secondary tuition and fees. With the expanded use of these accounts, below is a refresher on what the 529 plan offers and how to maximize it. 

What is a 529 Education Savings Plan?

A 529 education savings plan is a tax‐advantaged investment vehicle that provides for federal, state and local tax-deferred savings. Distributions are tax‐free if made for qualified higher education expenses (QHEE) at an elementary/secondary school, accredited college, university or vocational school. Qualified distributions may be limited by tax deductions and credits claimed each year. Distributions used for kindergarten through high school tuitions are limited to $10,000 a year. 

What are Qualified Higher Education Expenses in a 529 Plan?

Qualified education expenses as defined by the IRS include: 

  1. Tuition, fees, books, supplies and equipment (including computer technology or equipment as defined below).
  2. Expenses for special needs services, in the case of a special needs beneficiary, that are incurred in connection with enrollment or attendance.
  3. Expenses for the purchase of a computer or peripheral equipment, computer software, or internet access and related services — if such equipment, software or services are used primarily by the beneficiary during any of the years he or she is enrolled in an eligible institution. 

What is an Eligible Institution for a 529 Plan?

Eligible educational institutions for kindergarten through high school include public, private or religious schools. An eligible educational institution for higher education beyond high school includes any college, university, trade school or other post-secondary educational institution eligible to participate in a student aid program run by the U.S. Department of Education. 

Who Can Own the 529 Savings Plan?

529 plans are typically owned by parents or grandparents of the beneficiary. A current owner can transfer the plan to a successor owner, if desired. Successor owners can be anyone including the beneficiary; however, the successor owner takes the place of the owner and has total control over the account including distributions and refunds. Some plans limit how many times you can change the owner, so it’s a good idea to check with your plan adviser before making any changes. 

What Happens to Excess Funds in a 529 Savings Plan?

These funds do not expire. There is no time limit on when you must use the money or when you can change the beneficiary. If your child or grandchild has used the funds they need from an account you own and there is still excess in the account, here are a few options for the remaining funds. 

Transfer the funds to another beneficiary. Excess 529 savings plan funds can be transferred to another qualifying family member without income tax consequences. These funds can be used to pay for private K-12 education and college.
Qualifying family members who can benefit include the current beneficiary’s: 

  • Spouse
  • Child, step child, foster child, adopted child or other descendant
  • Sibling or step sibling
  • Parent or step parent
  • Niece or nephew
  • Aunts and uncles
  • Son-in-law, daughter-in-law, father-in-law, mother-in-law, brother-in-law or sister-in-law
  • First cousin 

In addition, the spouse of any of the individuals listed above can qualify. Designation of a new beneficiary not in the same or higher generation of the old beneficiary will be deemed a taxable gift. 

Leave excess funds in the account for the future. Future uses could include graduate school, vocational or trade school for the current or potential future beneficiary. 

Use the excess funds for non-qualified expenses. Funds can be pulled from a 529 savings account anytime, even for non-qualifying expenses. Since contributions to the account were made with after-tax dollars, they are not taxed again when taken from the account. Only earnings on the contributions are subject to income tax and the 10% penalty on non-qualified distributions. However, note that you cannot withdraw only from your contributions, or principal amount. Each withdrawal is made up of principal and earnings, so if there are gains in the account you will pay income tax and a penalty on those earnings for each non-qualified distribution.
When a non-qualified distribution is withdrawn from a savings account, the individual who receives the distribution, whether that’s the account owner or beneficiary, will be responsible for paying the tax and the 10% penalty on the income. 

The 529 Education Savings Plan can be a great tool to help your children, grandchildren or other designated beneficiaries pay for their education. Discuss the benefits and options with your financial and tax teams.

>> Learn more about related state deductions in “The Tax Deductions 7 States Offer for 529 Education Savings Plans.” 
Please contact a member of your service team, or contact Rachel Roan at rroan@cohencpa.com or Alane Boffa at aboffa@cohencpa.com for further discussion. 

Cohen & Company is not rendering legal, accounting or other professional advice. Information contained in this post is considered accurate as of the date of publishing. Any action taken based on information in this blog should be taken only after a detailed review of the specific facts, circumstances and current law.