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529 Plans: Understanding Changes to Help with College Funding

Financial advisers can help their clients with recent changes to tax laws related to 529 plans and how they can be used

For financial advisers whose clients are saving for their children’s college education, 529 college savings plans can be a good place to save and invest for this goal.

These plans offer the opportunity for money contributed to the child’s account to grow tax-free. If the money is withdrawn and used for qualified higher education expenses, there are no taxes or penalties on these withdrawals. Additionally, some states offer incentives for residents under certain conditions.

In advising savers on 529 plans, it's important that recent changes in some of the rules and other updates are taken into account.

Handling Refunds

Your clients might be receiving refunds for universities for room and board expenses that they paid for with money from a 529 plan. This has become a pretty common occurrence in 2020 with the move to virtual or hybrid schedules among many colleges and universities.

The rules are that this money should be put back into the 529 account within 60 days of receiving it, otherwise your client’s account could be assessed with a 10% penalty plus any applicable taxes.

If there are other qualified higher educational expenses for that student, such as tuition, books, lab fees, etc., conceivably this money could be used for that purpose. It’s not always clear how well this is tracked by the IRS, but at the very least your client should keep meticulous records regarding the use of these funds in case there is ever a question. It’s always possible the IRS will change the rules regarding these types of refunds at some point in the wake of the impact of COVID-19, but it’s not a good idea for clients to count on this.

SECURE Act Changes

The SECURE Act passed at the end of 2019 contained a couple of provisions impacting 529 plans that might factor into some of your client’s situations.

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The SECURE Act allows up to $10,000 to be withdrawn to repay the account beneficiary’s student loans on an aggregate lifetime basis. These student loan payments will be considered to be qualified expenses and the withdrawals will not be subject to taxes. In addition to the $10,000 for the account beneficiary, the same $10,000 limit is in place to repay student loan debt for each of the beneficiary’s siblings. As many of your clients may utilize a combination of sources to pay for college including student loans, this rule change allows money left over in a 529 plan to be used to pay off this student loan debt.

Note that any student loans paid with 529 funds are not eligible for the student loan interest deduction.

The SECURE Act also expanded the use of 529 funds to cover approved apprenticeship programs. Expenses related to programs offered by employers to train workers in industries such construction, healthcare, technology and a host of others are now considered to be qualified expenses. Expenses including fees, supplies, books and equipment needed within the industry covered by the program are considered to be qualified 529 plan expenses.

ABLE Accounts

The 2017 Tax Cuts and Jobs Act allows clients to transfer funds from a 529 account to an ABLE account for the same beneficiary or another family member as long as these transfers don't exceed the annual contribution limits for ABLE accounts. ABLE accounts are tax-advantaged accounts that can be used by individuals with disabilities for educational expenses without impacting their eligibility.

This can help with planning for educational needs for those clients with children with disabilities or special needs.

K-12 Educational Expenses

The Tax Cut and Jobs Act also allowed for the use of 529 assets to cover the cost of K-12 educational expenses. Presumably this would apply to clients who wish to send their kids to a private or parochial school as an alternative to their local public schools. Up to $10,000 can be used each year tax-free.

Whether or not this is a good use of these funds for your client is a planning issue. If they tap their 529 assets, will they still have enough to cover the college costs of the account beneficiary? Also, does their state follow the federal rules in not taxing these types of withdrawals?

Using a 529 plan to save for college expenses can offer a lot of advantages for your clients. It's important that you help them keep up on the latest developments in the rules for using these plans so their children can derive the maximum benefit.