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How Does a 529 Plan Work?

A 529 Education Savings Plan is a state sponsored plan that helps an account owner put money aside for educational purposes for a child, niece, nephew, or grandchild. The money is most often used towards higher education expenses, and depending on the state, can also be used for elementary school and secondary school tuition as well. These plans offer the account owner some great incentives, such as control over the funds, the flexibility to make contributions whenever and however they would like, and even some tax advantages.

How Does a 529 College Savings Plan Work?

The account owner, who must be an adult, owns the plan but anyone can make contributions. Contributions will be reported on the owner’s tax return for the tax advantages. The plan is created for a beneficiary, which can be a family member of any age. If the beneficiary chooses not to go to college, the plan can oftentimes be transferred to another eligible family member. If for some reason there is no one to transfer the funds to and they are not used for qualified expenses, they will incur a 10% penalty on investment earnings.

The money works as a retirement or investment plan. The account can be aggressive and mostly stocks when the beneficiary is younger and more reserved and mostly bonds when older and closer to college age.

Are There Limits?

The contribution limits normally depend on the state’s plan, but typically range from $235,000 to $550,000. Once the plan reaches this point, additional contributions will be prohibited and not allowed.

Contributions are considered gifts between family members. That means they also follow the guidelines of the Federal Gift Tax Exclusion. For someone filing their taxes as Single, they can give up to $16,000 per year, per beneficiary. If you are married filing jointly, you can give up to $32,000 per year, per beneficiary.

There is also a special election where the account owner can give up to five times that annual gift limit in one single year! This means the gift will be prorated over the next five years for the tax advantage. Just make sure not to give any more gifts until those five years are up!

What are the Tax Benefits?

The earnings on the 529 plan are tax free and any withdrawals out of the account are federal income tax free and penalty free if they are used for qualified education expenses. What is considered a qualified education expense? Some examples include tuition and fees, class books, required school supplies, room and board expenses if considered at least a half-time student (which can also include off campus housing up to the equivalent of what it costs to live on campus), computer and related equipment such as printers, internet access, and educational computer software, and travel.

For some states, you can even use these plans for elementary and secondary school, whether public, private, or religious with distributions of up to $10,000 per year, per beneficiary. These are also not subject to federal income tax.

Is my Institution Eligible?

An eligible educational institution is any school offering higher education beyond high school. This could be College, University, Trade School, or Post-Secondary Institutions. Pretty much any educational institution that is eligible to participate in a student aid program that is run by the U.S. Department of Education would qualify for a 529 plan.

Pennsylvania Benefits

Tax Deferred Growth: contributions grow free of federal and state income taxes while they remain in the account.

Tax-Free Withdrawals: if used for qualified educational expenses, no income tax on the growth of the account is paid.

Gift and Inheritance Tax Benefits: provide unique gift and inheritance tax benefits. The account owner retains complete control over the contributions in the account.

Elementary and Secondary School: Up to $10,000 distributions made for elementary or secondary public, private, or religious schools.

State Tax Parity: any contributions made to other states are eligible for PA State’s income tax deduction. Other states with this benefit are Arizona, Kansas, Maine, and Missouri.

SAGE Scholars Tuition Rewards Program: offers tuition discounts to 300+ private colleges nationwide, including over 50 in Pennsylvania.

Other: the plan can be used in the repayment of principal and interest on qualified education loans for the beneficiary or sibling that does not exceed $10,000. No Income Limit, anyone can contribute! Makes a great gift idea.

If you would like to talk to one of our professionals in our Entrepreneurial Support & Client Accounting Segment on this topic or any other business related topic, please do not hesitate to contact us.

About the Author

Alonia Johnston

Alonia joined McKonly & Asbury in 2022 and is currently a Senior Accountant in the firm’s Outsourced Accounting Segment.

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