It’s that time of year again when the kids head out to the bus stop in the morning to start a new year of learning, eager for what lies ahead. These children aspire to do great things, but with the rising costs of undergraduate education, families need to start saving earlier and the sooner the better. A 529 plan may be the answer and could benefit your estate plan as well.
A 529 plan is a tax-advantaged savings plan operated by a state or qualified educational institution that is designed to make it easier to save for college. There are two basic types of plans: prepaid tuition plans and college savings plans.
Prepaid plans let you lock in future tuition costs at today’s prices; whereas, college savings plans are designed to increase over time to cover tuition costs at the time the beneficiary begins college. Generally, the prepaid plans guarantee a minimum rate of return, but you will be limited to that rate. Conversely, the college savings plans generally do not have a guaranteed minimum rate of return so you will receive whatever return the stock market generates. Based on recent trends, this could be significant.
The main advantage of a 529 plan is that the earnings generally are not subject to federal or state income tax provided the funds are used for the qualified education expenses (i.e. tuition, fees, books, room and board) of the designated beneficiary. Although contributions to a 529 plan are not deductible on your federal return, some states, including Maryland, will allow you to deduct a portion of your contribution on your state return. In Maryland, you can deduct up to $2,500 each year per beneficiary with the ability to deduct excess contributions in the subsequent 10 years. This benefit is available only to those contributors who are the actual account holders and Maryland taxpayers.
Also, for federal gift tax purposes, any contribution to a 529 plan generally is considered a completed gift so it will reduce the value of your estate and will not be subject to estate tax when you die. However, there are contribution limits and if your yearly contribution exceeds $14,000 (in 2017) to any beneficiary, then you may have to file a gift tax return. But, you will not owe any gift taxes until you have given away more than $5.49 million (in 2017).
Another benefit to the 529 plan is its flexibility. Generally, the beneficiary may use the funds at any participating school even if they are a part-time student. Also, if a designated beneficiary does not use the funds in the account, you have the option to change the beneficiary designation, or roll it over tax-free to another plan.
The biggest disadvantage is that if the funds are not used for qualified education expenses then the earnings are subject to federal and possibly state income tax. Additionally, a 10 percent federal penalty will be imposed on the withdrawal. Further, for Medicaid purposes, a 529 plan likely is a countable asset that must be spent-down before you will be eligible for benefits and could have other negative consequences.
Call ERA Law Group, LLC today at (410) 919-1790 and ask how we can help you save for your children’s future!