How much do you know about a 529 savings plan? If you are currently researching about this helpful savings plan, or just want to learn more, take a look at the following must-know terms.
Also, be sure to check out 8 Questions to Ask Before Starting a 529 Savings Plan and Pros and Cons of a 529.
Section 529 code: The section of the IRS that authorizes 529 qualified tuition plans and codifies the legal jargon and guidelines for the 529 plans.
529 Savings Program: This savings program enables participants to save money in a college savings account for a designated beneficiary. Money put into the account as well as earnings on the account can be used to pay for the beneficiary’s qualified higher education expenses. The plans offer a multitude of investment options that provide a variable rate of return usually based on stock or bond funds. Some plans include investment options that guarantee a minimum rate of return.
529 Prepaid Tuition Program: This program allows parents, grandparents, or any other interested parties to purchase future tuition at today’s rate. Tuition can be purchased in years or units through a one-time lump sum or monthly installments. Once that is done, the program pays the future college tuition of the beneficiary at any of the state’s eligible colleges or universities. It will also make comparable payment to private or out-of-state institutions. The program pools the money to make investments that will ensure the earnings meet or exceed college tuition increases in that state.
Federal tax benefits: Although contributions to a 529 plan are not eligible to be deducted on the federal tax return, the investment grows tax-deferred, and withdrawals to pay for the beneficiary’s college costs are typically federally tax-free.
State tax benefits: Different states offer different benefits for participants of 529 plans. Your state may offer tax breaks, such as an upfront deduction for your contributions or income exemption on withdrawals. Click here to see what benefits you receive in your state.
Tax reporting: You do not need to disclose the fact that you have a Section 529 plan to the IRS on your income tax return, ever. There’s no limit to how much you can contribute in one year, or how many plans you can fund, although fully funding a plan or multiple plans in one lump sum may result in gift/ or Generation – Skipping Transfer tax considerations.
Enrollment: Enrolling can be as easy as downloading a form from the Internet, filling it out and mailing it in. Some states let you open an account completely online. Some plans restrict enrollment to only a few specific months, but most are open year-round. You can open an account with as little as $25 or $50, and can pay by check or set up monthly contributions through payroll deduction or automatic withdrawal from a bank account.
Donor: The donor is the person who owns the account, and stays in control of it. With few exceptions, the donor has sole rights to decide when withdrawals are taken and for what purpose. The beneficiary actually has no rights to the fund (rarely are there exceptions). The donor can even take the funds back for themselves at any time, no questions asked. However, the earnings portion of the withdrawal will be subject to income tax and an additional 10% penalty tax.
Beneficiary: The beneficiary is the person receiving the funds (the donor can name him or herself as the beneficiary).
FAFSA: FAFSA stands for Free Application for Student Aid. Federal Student Aid is a part of the U.S. Dept. of Education and is the largest provider of student financial aid in the nation. It provides over $150 billion in federal grants, loans, and work-study funds each year. The application is required in order for students to apply for financial aid. Click here for the FAFSA site.
Assets: 529 plans should be reported on a student’s FAFSA as an asset. Depending on who is the owner of the plan it can be reported as a parent asset or a student asset. If the student is a beneficiary of a 529 plan not owned by their parents or themself, it is not reported as an asset, but distributions from the plan are treated as income to the beneficiary. If the parents are divorced and the 529 plan is owned by the noncustodial parent, the plan is not reported as an asset.
Penalty: A 10% penalty is incurred on earnings for non-qualified (as in not going towards the beneficiary) distributions. An exception to this penalty is if the account has been terminated because the beneficiary has died or is disabled, or given a scholarship. Aside from the penalty the non-qualified distribution will be subject to tax as ordinary income.
Gift tax: As of January 2013 a person can give up to $14,000 worth of assets away to a recipient and not be taxed with a gift tax.
Aggregator: Third-party sites that function as middlemen to advise donors on 529 planning.