A Tax-Efficient Way to Pay for Education

With the cost of education on the rise and student debt looming large in the public conversation, it’s only natural that families would be looking for ways to save a bit of money while securing an academic future for the next generation. One well-known but underutilized option, the 529 college savings plan, has recently become even more attractive thanks to recent legislative changes.

Let’s explore these accounts: what they are, what has changed, and how they may help serve your financial planning goals.

What is a 529 Education Account?

The 529 college savings account program began in the late 80s as a way to help with college costs. It has since expanded to apply to costs related to trade schools, vocational schools, and even tuition at private K-12 schools.

The program is managed on the state level, so the specific rules and guidelines can vary a bit from one location to the next, but the general idea is that a 529 is a tax-advantaged savings account that is used for education expenses.

It is important to realize that you are not required to use your home state’s 529 plan. You can use the 529 from any state, no matter your state of residence or the location of the school you plan to pay for. Additionally, you can choose to manage your own account with a self-directed 529 or work with a financial advisor to build a strategy for the account.

A Tax Advantaged Way to Pay for College

There are many ways to set money aside for college, but 529s offer a few advantages that other types of savings accounts do not.

Contributions

As of 2023, each individual can contribute up to $17,000 per beneficiary per year without any gift tax considerations. These are considered completed gifts to the beneficiary so annual gifting limits apply.

What’s unique about 529s, however, is you are able to accelerate the funding, up to five years of gifting ($85,000 per person per beneficiary) all in one year, with no gift tax concerns.

This is especially powerful because some states, including New Mexico and Arizona, offer state tax deductions for 529 contributions:

  • New Mexico: Unlimited state tax deduction for contributions to the New Mexico 529 plan only.
  • Arizona: Limited state tax deduction up to a $2,000 ($4,000 married filing jointly) per beneficiary to any state’s 529 plan.

Every state is different so it is important to do your homework before selecting a plan. Be sure to speak with your financial and tax advisor about these and other benefits that may apply to your unique situation.

Investments

You are then able to take your contributions and invest them tax-deferred just like a 401(k) or IRA. Investment options can range from FDIC insured cash to target date funds to individual mutual funds.

Investment options vary widely from plan to plan so it is important to review the options and costs with your financial advisor.

Withdrawals

Finally, withdrawals are tax-free as long as they are used on qualifying educational expenses. For college, these expenses include nearly everything, such as tuition, textbooks, and room and board.

In recent years, the eligible expenses have expanded to include trade and vocational schools, private K-12 tuition, and even some international schools. Additionally, you can now use up to $10,000 to repay student loans.

It is important to confirm the expenses you are paying for are qualified education expenses. Keep good records, and consult with your tax professional when in doubt.

What Else Is Unique About a 529 College Savings Plan?

529s can only have one owner and one beneficiary. Normally, but not always, the owner and the beneficiary are different people. Most commonly, a parent owns the account and makes deposits for the benefit of a child.

But anyone who wants to make contributions into a 529 may do so, even if they are not the owner. Regularly, grandparents want to contribute to a grandchild’s 529 and they can do so without needing to set up a separate account.

Once established, both ownership and the beneficiary of a 529 can be changed. For example, a parent can open a college account for one child, then change beneficiaries if that child chooses a different path. A parent can open an account and transfer ownership to the grandparents, or vice versa.

Another interesting recent change now allows for 529 to Roth IRA conversions. There are several stipulations regarding this strategy, but it is important to be aware of as you plan.

All this flexibility also makes them useful tools for estate planning, providing people with more options for passing wealth forward to younger generations.

How Recent Changes to the FAFSA Affect 529s

The Federal Application for Student Aid (FAFSA) provides a thorough review of a student’s financial situation and access to assets in order to calculate their access to financial aid.

Traditionally, all 529 accounts have been viewed as an asset and/or source of income when calculating student aid. However, as of this year, only the college fund owned by a student or their parent counts on a child’s FAFSA form. A 529 owned by a grandparent or other family member does not.

This means a student can still receive need-based aid such as grants and scholarships while benefiting from a family member’s financial assistance. This is a great opportunity for maximizing the value of your education dollars, and it’s one of many potential benefits to setting up this type of college savings fund.

If you’re interested in learning more or have questions about other financial strategies that can benefit your family, our financial advisors are here to help. Call our Albuquerque office at 505-881-5100 or Scottsdale at 580-565-6100 for financial advice tailored to your specific needs and situation.

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