What Is a 529 Plan and How Can It Benefit Your Family and You?

September 19, 2016

Authored by: Olivia R. Holcombe-Volke, J.D. – olivia@209.59.156.181, 443-393-7696

When 529 college savings plans first arrived on the scene (Section 529 of the Internal Revenue Code was adopted in 1996), the primary motivation was addressing the reality of rising college tuition. Through various subsequent iterations, including those of the Economic Growth and Tax Relief Reconciliation Act of 2001 and the Pension Protection Act of 2006, qualified distributions became tax-free, rollovers became allowable, and account owners became able to make some investment changes, expanding the appeal of 529 plans beyond merely paying for the ever increasing costs of college.

What is a 529 plan? Legally known as a “qualified tuition plan,” a 529 plan (so called because authorized by Section 529 of the Internal Revenue Code) is a tax-advantaged savings mechanism to pay for future college costs. There are two types:  a pre-paid tuition plan, and a college savings plan. With a pre-paid tuition plan, units or credits toward future tuition and room and board are purchased from participating colleges and universities. With a college savings plan, an account holder establishes an account on behalf of a beneficiary (the current or future college student) in order to pay the beneficiary’s eligible college expenses. The account holder may select among various investment options for the contributions made to the account, with the particular college savings plan then investing the contributions on behalf of the account holder. Withdrawals from these plans can then be used at most, if not all, colleges and universities.

The tax implications of contributing to a 529 plan are almost exclusively positive.  Contributions to a 529 plan for the benefit of someone else will move assets out of one’s estate – thereby lowering potential exposure to estate tax.  Any growth in assets invested in a 529 plan will also avoid inclusion in the contributor’s estate.  Gift tax consequences are avoided if annual contributions remain at or below the annual exclusion amount (with no additional gifts in that year to the same beneficiary).  In fact, under special rules applicable to 529 plans, five years’ worth of the annual gift exclusion amount may be contributed (and a special tax election made) without gift tax ramifications; however, the contributor’s death during the five years following the contribution will result in the inclusion of a portion of the contribution in the contributor’s estate.  Finally, while contributions are not deductible for federal tax purposes, Maryland provides a deduction for contributions to the Maryland 529 Plans of up to $2,500 per beneficiary, per year, for contributions made that year, with contributions in excess of $2,500 eligible for deductions for up to the next ten (10) years (or until the full amount of contributions has been deducted).

A 529 savings plan account can be established for the benefit of anyone – a friend, relative, or anyone else – and that beneficiary can be changed at any time, without consequence, so that if a beneficiary receives a scholarship, or decides not to attend college, a new beneficiary may be named without penalty.  Additionally, there is no limit to the number of plans that can be set up.  The opportunities presented by contributing to 529 savings plans are immense:  for minimizing estate tax exposure; for providing a legacy that will be put to good use; for the ability to push assets out of one’s estate while still maintaining some level of control over their investment, use, and ultimate disposition.  This combination of benefits is unusual.  If any aspect of this technique is applicable or appealing to you, your estate, and/or your preferred beneficiaries, it is worth discussing with your estate planning attorney today.

Addendum:  On April 12, 2016, Governor Hogan signed the Achieving a Better Life Experience (ABLE) Act into law, joining thirty-nine (39) other states in providing a mechanism for many individuals who developed disabilities prior to the age of twenty-six (26) with the ability to open tax-exempt bank accounts to hold funds for use toward certain qualifying disability-related expenses, without the risk of negatively impacting eligibility for means-based government benefits.  Specifically with regard to 529 savings plans, the ABLE law provides for the Maryland 529 Board (formerly the College Savings Plans of Maryland Board) to establish and administer 529 accounts for individuals with disabilities, offering Maryland income tax subtraction modifications similar to those available for contributions to 529 accounts for non-disabled individuals (though more limited), and, most importantly, without the funds in such 529 accounts counting against an individual’s ability to qualify for means-tested benefits.

____________________

1 Nothing in this article is intended as tax advice.  All readers are advised to speak with a tax professional regarding any federal or state-specific tax applications.