529 Education Savings Plans

Section 529 College Savings Plans (“§529 Plans”) are flexible, tax-advantaged investment accounts specifically designed to help families save for future college education costs.  These plans are established in Section 529 of the Internal Revenue Code and require state sponsorship for participants to be eligible for federal income tax benefits.  529 Plans are offered by individual states, but you do not have to be a resident of a particular state to invest in that state's plan.

The principal advantage for investing in §529 Plans is that all earnings (i.e., interest, dividends and capital gains) realized on the amounts invested are compounded tax-free at the Federal and state levels. Nor are these earnings taxed when withdrawn, as long as they are used for qualified educational expenses such as tuition, room and board, books, computers and internet access, and equipment.

Tax Tip

Normally, parents of college students aggregate funds together from various accounts to pay tuition bills due in August or December, prior to the start of the next semester.  However, Congress managed to overlook this normal family financial management process when they enacted Section 529 of the Internal Revenue Code.

When you need to withdraw funds from a §529 College Savings Plan to pay tuition, you should ask the fiduciary to do so via either of the following approaches: 

  1. Make the check payable directly to the college, university, or higher education institution.
  2. Make the check payable to the beneficiary (usually, your son or daughter) of the §529 College Savings Plan.  Then have the beneficiary endorse this check over to you. 

If instead the fiduciary makes the check payable to either parent, the fiduciary will issue a Form 1099-Q that will report the distribution from the §529 Plan to that parent – who is NOT the beneficiary!  As a result, most or all of this §529 Plan distribution will be taxable income to the parent – clearly, not the desired outcome.

What If The Beneficiary Decides Not to Pursue a College Education?

Some designated beneficiaries may decide not to pursue higher education opportunities at a college or university. They may decide to get married and start a family, begin a career in the building trades or in automotive repair, enlist in military service, or any of several other alternatives.

The owner of the beneficiary’s §529 Plan – usually the parent or grandparent who established this §529 Plan on behalf of the beneficiary – has several options available: 

  1. Designate a new beneficiary for this §529 Plan account. Speak with a representative of the fiduciary who is managing this §529 Plan account, and complete some paperwork.
  2. Withdraw the funds and close this §529 Plan account. All contributions returned to the owner are not subject to any Federal or State income tax, as these contributions were made using after-tax dollars. All investment earnings – Interest, Dividends & Capital Gains - returned to the owner will be treated as long-term capital gains (LTCGs) subject to Federal and State income tax.
  3. One of the provisions of the SECURE Act 2.0 of 2022 permits beneficiaries of §529 college savings accounts to rollover leftover funds from any §529 account in their name into their Roth IRA. Such rollovers are subject to several restrictions:

a.    The §529 account must have been open for more than 15 years.
b.    All such rollovers must be initiated on a direct fiduciary-to fiduciary basis.
c.     The amount rolled over cannot exceed the total amount contributed to the §529 account more than five years before the rollover.
d.    The maximum amount that can be rolled over is $35,000 over the course of the beneficiary’s lifetime.
e.    Such rollovers are subject to Roth IRA annual contribution limits.
f.      Roth IRA income limit restrictions are not applicable to §529 Roth conversions.

As a result of this new SECURE Act 2.0 provision, individuals will have the option to avoid incurring the penalty on a non-qualified withdrawal of leftover §529 plan funds.

This new SECURE Act 2.0 provision applies to such §529 account distributions made beginning January 1, 2024 or later.

Additional Information

Although it’s usually parents and grandparents who open §529 Plan accounts, any U.S. resident who is 18 years or older can open one. When you open a §529 account, you are the owner, or “participant”. You control the §529 account. You decide when and how much money to invest, and you’re in charge of distributing the money. The beneficiary of the account can be anyone you choose, including yourself, as long as they have a Social Security or Federal Tax ID number. You can change the beneficiary at any time.

For 2021 and 2020, the annual §529 Plan contribution limit is $15,000 per Plan beneficiary. An individual may contribute up to $15,000 into another individual’s §529 Plan each year, without incurring any gift tax liability or Form 709 Gift Tax filing. A married couple may contribute up to $30,000 into an individual’s §529 Plan (i.e., a “split gift” of $15,000 each).

An individual may contribute as much as $75,000 into a §529 Plan if they treat the contribution as if it were spread over a 5-year period. The 5-year election must be reported on Federal Form 709 for each of the five years. For example, a $50,000 §529 Plan contribution made in 2021 can be applied as $10,000 per year, leaving $5,000 in unused annual exclusion per year.
This is often called “5-Year Gift Tax Averaging” or “Superfunding”.
Using 5-year gift tax averaging, an individual can make a contribution of up to $75,000 (i.e., five (5) gifts of $15,000 each) into a beneficiary’s §529 Plan.  A married couple may contribute up to $150,000 into an individual’s §529 Plan (i.e., five (5) “split gifts” of $15,000 each). Such contributions are treated as though they were spread evenly over a five-year period starting with the current calendar year. The lump sum contribution will use all or part of the annual gift tax exclusion for the donor during the five-year period. The only limitation is that the donor is prohibited from making any additional tax-free gifts to that recipient for the next five years.
The gift of up to $75,000 into a §529 Plan does not have to be made all at once, either. The donor is allowed to make periodic contributions of whatever amount at whatever frequency, so long as the total amount contributed into the §529 Plan does not exceed $75,000 in that year.
For example, a grandparent can give up to $75,000 in 2021 to each grandchild without having to pay gift taxes, based on the $15,000 annual gift tax exclusion. The grandfather and grandmother can together jointly give up to $150,000 to each grandchild. The grandparents will be unable to give any more money to each grandchild in 2021, 2022, 2023, 2024 and 2025.
This is often a great estate-tax planning strategy for parents and grandparents. They’re able to shelter a large amount of assets from estate taxes, while retaining control of the funds in the §529 account. However, if they decide to change their mind down the road and revoke the funds out of the §529 account, those funds will be added back to their taxable estate.

If you contribute more than $15,000 in one year or $75,000 over five years, will you have to pay Federal gift taxes? Not necessarily. As mentioned above, any gifts above the annual exclusion amounts must be reported on Federal Form 709, and these amounts will be counted against the $11.7 million lifetime gift tax exclusion. Any amounts that exceed the exclusion could trigger gift taxes of up to 40%.  However, individuals who stay within the $11.7 million limit will not be subject to Federal gift taxes.

§529 Plan Contributions are not deductible on your Federal income tax return.

The State of New Hampshire offers two §529 Plans that are administered by Fidelity Investments with fiduciary oversight provided by the College Tuition Savings Plan Advisory Commission. All Plan assets are held in trust with the New Hampshire State Treasurer serving as Trustee pursuant to RSA 195-H:4,IV.

UNIQUE College Investing Plan - This Plan is offered directly to Fidelity retail investors.
Fidelity Advisor 529 Plan - This Plan is marketed to the clients of non-Fidelity financial advisors that do not administer their own proprietary plan.

The Commonwealth of Massachusetts offers two §529 Plans through the Massachusetts Educational Financing Authority (FEMA), a not-for-profit state agency whose mission is to help Massachusetts students and families access and afford higher education and reach financial goals through education programs, tax-advantaged savings plans, low-cost loans, and expert guidance.

U.Fund College Investing Plan - This is a tax-advantaged investment plan, professionally managed by Fidelity Investments. The U.Fund College Investing Plan follows the same approach as other Fidelity plans established in Arizona, Delaware and New Hampshire. It features three age-based options; one using Fidelity mutual funds; one using Fidelity index mutual funds; and a third multi-firm option with portfolios that invest in funds offered by several different companies. The plans also offer 11 static options, and one option that invests in an interest-bearing deposit account.
U.Plan Prepaid College Tuition Plan - Participants purchase tuition certificates that lock in tuition and mandatory fees at their current rates. Earnings on the bonds that back the certificates are tax-free. The U.Plan can only be used to attend one of approximately 80 Massachusetts colleges or universities.

Massachusetts §529 Plan Tax Benefits

Beginning in 2017, Massachusetts residents can claim a deduction for contributions they make into a Massachusetts §529 Plan on Massachusetts Schedule Y.  This deduction is limited to $2,000 (married couples filing jointly; $1,000 for single filers).  These contributions must have been made into either of the Massachusetts §529 plans described above.
This Massachusetts deduction for contributions made into a Massachusetts §529 Plan remains in effect through the 2021 tax year.

Beginning with the 2018 tax year, the IRS allows account owners to withdraw up to $10,000 of §529 Plan funds annually to pay for elementary and high school education at a public, private or religious school. This can be a big help to parents who want to enroll their children in private schools.

The owner of a §529 Plan can withdraw funds from the Plan at any time for any reason. If such funds are not used to pay for educational expenses, this is known as an “unqualified withdrawal”.  The withdrawal of contributions that you invested into the Plan is treated differently from the withdrawal of earnings accrued in the Plan for income tax purposes.
Since you already paid income tax on contributions than you had invested into the Plan, you can withdraw your contributions both Federal tax and penalty free.
However, any earnings withdrawn will be subject to both Federal and state income taxes at ordinary rates (i.e., not at preferential capital gains rates) and an additional Federal unqualified withdrawal penalty of 10 percent.

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